Theme 2 - Aggregate demand Flashcards

Question

what is business confidence determined by

Answer 1

📉 1. Macroeconomic Stability If inflation, interest rates, and exchange rates are stable → It becomes easier for firms to plan for the future without sudden cost shocks → This reduces uncertainty and encourages long-term investment → So macroeconomic stability raises business confidence. 🏛️ 2. Government Policy and Regulation If firms expect supportive fiscal or supply-side policies (e.g. tax cuts, deregulation) → They are more likely to believe that the economic climate will be favourable for growth → Reduced red tape or lower corporation tax boosts expected profits → Leading to higher business confidence and investment. 🌍 3. Global Economic Conditions If global demand is rising (e.g. major trading partners are growing) → Export-oriented businesses will expect higher sales and profits → This encourages expansion and hiring to meet future demand → So strong global conditions can raise domestic business confidence. 🧑‍💼 4. Consumer Confidence and Spending If consumers feel optimistic about their income and jobs, consumption rises → Firms see increased demand and anticipate higher future revenues → This encourages them to invest in capacity, innovation, and hiring → So high consumer confidence directly boosts business confidence.

Answer 2

the profit left after corporation tax has been paid

Answer 3

a tax on business profits

Answer 4

when there is an increase in rate of real gdp in the economy and that encourages further investment

Answer 5

the part of disposable income which is not spent on goods and services in the economy

Answer 6

- increased savings will decrease consumption, which is a variable in the AD equation, and vice versa

Answer 7

💷 1. Real Disposable Income When real disposable income rises → Households have more income after tax and inflation → This allows for both higher consumption and increased savings → So the marginal propensity to save (MPS) may rise, depending on income levels and expectations. 💰 2. Interest Rates Higher interest rates increase the reward for saving → The opportunity cost of spending rises, encouraging households to save more → A higher MPS reduces consumption, shifting AD to the left → Conversely, low interest rates discourage saving and promote consumption. 😟 3. Consumer Confidence If consumer confidence is low (e.g. due to recession fears or job insecurity) → Households may choose to increase precautionary savings and cut spending → This reduces the marginal propensity to consume (MPC), slowing economic growth → So pessimism in the economy leads to higher savings levels. 🏦 4. Financial Infrastructure and Trust In countries with well-developed, secure financial systems → People are more likely to save through banks, pensions, and financial products → In contrast, in developing economies with corruption or instability, trust in banks is low → This may lead to less formal saving and more current consumption. 🎓 5. Education and Financial Literacy If individuals are educated about the long-term benefits of saving → They are more likely to budget, delay gratification, and plan for retirement or emergencies → This increases the marginal propensity to save in the long term → Boosting national saving rates and potentially supporting investment. 🏦 6. Tax Incentives (e.g. ISAs) Government schemes like Individual Savings Accounts (ISAs) or pension tax relief → Allow people to earn interest or returns tax-free → This increases the net reward for saving and encourages long-term financial planning → Raising overall household savings and supporting capital markets. 👵 7. Age Structure of the Population Younger individuals are typically in a consumption-heavy life stage (education, housing, family) → Older individuals are more likely to save for retirement or draw down savings more slowly → An ageing population may increase national savings (or reduce it if people are withdrawing pensions) → So the age structure influences both the MPS and national saving trends.

Answer 8

⚖️ 1. Elasticity of Demand for Exports Even if a factor (e.g. weaker exchange rate) makes exports cheaper → The impact on export value depends on the price elasticity of demand → If demand for exports is inelastic, a fall in price won’t boost export revenue much → So export volumes may rise, but overall revenue gains could be limited. 🌍 2. Global Economic Conditions Matter More A country may boost its competitiveness or weaken its currency → But if trading partners are in a recession, their demand for imports falls → This weakens export demand regardless of price advantages → So global context may override domestic improvements. 🏭 3. Export Supply Constraints Even if demand for exports rises (e.g. due to a weaker currency or trade deals) → Domestic firms may lack the capacity or resources to scale up output (due to skills shortages or capital limits) → This limits how much export volume can actually increase → So gains may not materialise unless LRAS also expands. 📉 4. Time Lags and J-Curve Effect Following a currency depreciation or trade policy change → Export volumes may take time to adjust (e.g. firms need to find new customers, contracts are fixed short-term) → This means that in the short run, exports might not rise → But in the long run, export values may increase if Marshall-Lerner conditions are met. 🧮 5. Relative Inflation Rates Even with a weak exchange rate, if domestic inflation is high → The real price of exports might not actually fall by much → High costs make exports less competitive in global markets → So inflation can cancel out expected benefits to exports. 🔧 6. Degree of Specialisation and Innovation The long-term ability to grow exports relies on non-price factors → Countries with highly innovative or specialised export sectors (e.g. Germany’s engineering, South Korea’s tech) → Can maintain strong exports regardless of short-term cost fluctuations → So competitiveness isn't just about prices, but also quality and branding.

Answer 9

SHORT RUN - After a currency depreciation, the prices of imports rise immediately,imports more expensive. - Export prices in foreign currency terms may not adjust as quickly, causing the value of exports to remain relatively unchanged initially. - As a result, the trade balance worsens because the higher cost of imports outweighs the unchanged value of exports. LONG RUN - Over time, consumers and businesses adjust to the new prices. Import volumes start to decline due to higher costs, and export volumes increase as foreign demand rises for relatively cheaper goods - Eventually, the trade balance improves as the volume effects of increased exports and reduced imports outweigh the initial price effects. The increased competitiveness of the country's goods leads to higher export revenues, and the reduced import demand lowers import expenditures.

Answer 10

Disposable income is the amount of income a household has left after paying taxes and receiving government transfers. It is used for consumption or savings.

Answer 11

Gross investment is the total amount spent on capital goods, including replacement and new investment. Net investment is gross investment minus depreciation (the reduction in value of capital goods over time). Net investment represents the actual increase in capital stock.

Answer 12

refers to the emotions and instincts that drive business decisions, especially investment. Confidence, optimism, or fear can strongly influence business investment, sometimes regardless of economic fundamentals.

Answer 13

the difference between a country's exports (X) and imports (M)

Answer 14

Actual growth refers to the increase in real national output (GDP) over time, measured by the actual output produced in the economy. Potential growth refers to the increase in the economy’s capacity to produce goods and services over time, measured by the economy's long-run trend growth.

Answer 15

Actual Growth Rates: Definition: The actual percentage increase in a country's real GDP (Gross Domestic Product) over a specific period, typically a year. Long-Term Trends in Growth Rates: Definition: The average sustainable rate of economic growth over a longer period, reflecting the underlying potential of an economy.

Answer 16

💱 1. Exchange Rate Distortions GDP figures must be converted into USD using exchange rates → But exchange rates can fluctuate daily due to speculation, interest rate changes, or political instability → This may distort the true value of output when converted to dollars → Making comparisons inaccurate, especially in the short run. 🧺 2. Cost of Living Differences A dollar can buy different quantities of goods in different countries → For example, $1 buys more in India than in the US due to lower local prices → So nominal GDP in USD may underestimate real living standards in low-cost economies → Leading to misleading conclusions about development or welfare. 📉 3. Impact of Currency Depreciation If a country’s currency depreciates (e.g. due to a crisis), its GDP in dollars will fall → Even if domestic output and welfare stay the same → This gives a false impression of economic decline → So dollar comparisons can confuse exchange rate changes with real output changes. 📊 4. Does Not Reflect Informal or Non-Market Output In many developing economies, a large share of GDP comes from informal or subsistence activity → These are hard to measure accurately in national statistics, especially when valuing in USD → The use of the dollar may therefore exclude significant portions of real economic activity → Undermining fair international comparisons.

Answer 17

📉 1.1 Economic Recession During a recession → government expenditure often increases → to stimulate demand and support the economy → higher spending on welfare, unemployment benefits, and public infrastructure 📈 1.2 Economic Expansion In periods of economic growth → government expenditure may decrease → due to reduced need for stimulus measures → more revenue from taxes, reducing reliance on public spending 💸 1.3 Inflationary Pressures When inflation rises → government may increase spending on subsidies or price controls → to protect consumers from rising costs → maintaining economic stability and consumer purchasing power If the government aims to reduce unemployment → they may increase public sector investment → to create jobs and stimulate demand → boosting economic activity and reducing unemployment rates 💰 2.2 Budget Deficit or Surplus If the government is running a deficit → it may increase expenditure on public goods → to stimulate demand and promote growth → or it may reduce spending in case of a surplus to control inflation 💳 2.3 Taxation Levels When the government raises taxes → it may reduce disposable income → leading to lower private consumption → the government may counter this with higher public sector spending to support demand

Answer 18

🔹 1. Interest Rates ↑ → Asset Prices ↓ 📉 Central bank raises interest rates → Borrowing becomes more expensive and saving becomes more attractive → Demand for assets like houses or shares falls as investors shift to interest-bearing assets → 🏠📊 Asset prices fall due to lower demand and higher discounting of future returns 🔹 2. Interest Rates ↓ → Asset Prices ↑ 📈 Interest rates are cut by the central bank → Lower cost of borrowing encourages investment and mortgage lending → Demand for assets like property and equities rises → 🏘️📈 Asset prices increase due to higher demand and lower discount rates 🔹 3. Stock Market Valuations Affected via Discounting Future company profits are discounted at prevailing interest rates → When interest rates fall, the present value of future earnings rises → This makes shares more valuable, even if profits haven’t changed → 📊 Stock prices go up due to revaluation of expected returns 🔹 4. Wealth Effect from Asset Price Changes Higher asset prices increase household wealth → Wealthier households may increase consumption (positive wealth effect) → This can further boost demand for assets, creating a feedback loop → 💷 Economy experiences a rise in confidence and spending, especially in housing markets

Theme 2 - Aggregate demand Flashcards

(42 cards)