Download Aggregate Demand

IB Economics
What is Aggregate Demand (AD)
and how do we influence it?
Understanding Aggregate Demand
(AD)
• Aggregate Demand (AD) =
– Total level of planned real expenditure on UK
produced goods and services
• The components of aggregate demand
• Household Spending (C)
• Gross Fixed Capital Spending (I)
• Government Consumption (G)
• Exports of Goods and Services (X)
• (minus) Imports of Goods and Services (M)
• AD sums to GDP (expenditure based)
The Aggregate Demand Curve
An AD curve is drawn assuming all
factors affecting aggregate demand
are being held constant except the
general price level. A change in
factors affecting any one or more
components of aggregate demand,
household (C), firm (I), government
(G) or foreigners (X) changes
planned aggregate demand and
results shift in the AD curve
Price Level
P2
P1
P3
AD1
Y2
Y1
Y3
Real National Output
An Outward Shift in Aggregate Demand
Price Level
P1
AD2
AD1
Y1
Y2
RNO
Recent Government Actions - AD
Back spending plan, urges Obama
US President-elect Barack Obama has called for "drastic action" to
prevent the US economic situation worsening. Speaking two weeks before
taking office, Mr Obama urged Congress to act quickly to pass an $800bn
(£526bn) stimulus plan.
His proposals include tax cuts and creating new jobs through increased
government spending on public works projects. He called on political leaders
from all sides to come together behind a bill. Mr Obama is facing his first big
battle to persuade Congress to approve a colossal effort to restart America's
economy, reports the BBC's Adam Brookes, in Washington.
His warnings were more dire than anything before, our correspondent adds,
and he is piling on the pressure for action.
Source: Modified from http://news.bbc.co.uk/2/hi/business/7819290.stm | 9th January
2009
How does increased
government spending affect AD?
Price Level
RNO
An Inward Shift in Aggregate Demand
Price Level
P1
AD3
AD4
Y4
Y3
Real National Output
Recent Government Actions - AD
Source: http://news.bbc.co.uk/2/hi/business/7522741.stm | 24th July 2008
How does increasing the rate of interest
affect AD?
Price Level
RNO
Causes of Changes in AD
•
Changes to Government Fiscal Policy
– An increase/decrease in level of taxation
– Changes in real government spending on health, education,
transport
– An increase in the size of the budget deficit (where government
spending > tax revenue)
•
Changes to Monetary Policy
– Changes in official base interest rates by the Bank of England
– Fluctuations in the exchange rate for sterling (e.g. a fall in the value
of sterling against the Euro or the US dollar)
•
Changes in Business & Consumer Confidence
•
Fluctuations in the growth of national income and expenditure in
other countries (the global economic cycle)
– E.g. the effects of a recession in the United States
– A cyclical recovery within the Euro Zone
How do changes in the rate of interest affect
the level of business investment?
R (%)
Level of Investment
The UK and Global Economic
Fluctuations
– Demand-side economic shocks
• Growth of income & demand in OECD economies
– E.g. an economic recession in the United
States
– Asian economic downturn / financial
turbulence
• Interest rates decisions in Europe and in the USA
• Performance of global stock markets - particularly in
the USA
• Foreign Investment decisions of global multinationals
– Supply-side economic shocks
• Fluctuations in international commodity prices
How will the global economic downturn
affect Dubai?
How will the global economic downturn
affect Dubai?
Price Level
RNO
Fiscal Policy and Aggregate Demand
AD = C + I + G + (X-M)
Where;
– C = Consumption
– I = Investment
– G = Government Spending
– X = Exports
– M = Imports
Fiscal Policy and Aggregate Demand
•
Fiscal Policy can affect AD through several channels
•
Direct changes in government spending (current and capital)
•
Changes in direct taxes
– Income tax / National Insurance
– Corporation tax
– Taxation of saving
•
Tax incentives for R&D
•
Changes in indirect tax
– Changes in excise duties e.g. cigarettes and alcohol
– Changes in VAT, the UK recently reduced VAT to 15% to
stimulate demand (it will return to 17.5% in 2010)
•
Changes in the budget deficit or surplus, in an attempt to
stimulate the US economy it has been forecasted that the
government will borrow $1.8 tn in this financial year
Taxes and Aggregate Demand – what
happens when the economy is growing too
SLOW?
Cut in personal
income tax
Boost to disposable
income
Adds to consumer
demand
Cut in indirect
taxes
Lower prices –
higher real
incomes
Adds to consumer
demand
Cut in
corporation tax
Higher “post
tax” profits for
businesses
Adds to business
capital spending
Cut in tax on
interest from
saving
Boost to disposable
income of people
with net savings
Adds to consumer
demand
Expansionary
Fiscal Policy
Taxes and Aggregate Demand – what
happens when the economy is growing too
QUICK?
Contractionary
Fiscal Policy
Monetary Policy and Aggregate
Demand
Interest
Rate
Channel
Bank
Lending
Channel
Exchange
Rate
Channel
Wealth
Effect
Channel
Expansionary
Monetary
Policy
Lower
Nominal
Interest Rates
Stimulates
Capital
Investment
Spending
Increase in
Economic
Activity
Expansionary
Monetary
Policy
Increase in
Bank Loans
Stimulates
Household
Spending
Increase in
Economic
Activity
Expansionary
Monetary
Policy
Exchange
Rate
Depreciation
Stimulates
Net Exports
Increase in
Economic
Activity
Expansionary
Monetary
Policy
Rise in Equity
Prices
Rise in House
Prices
Rise in Value
of Household
Wealth
Increase in
Economic
Activity
Tasks
Today’s Classwork
• Complete student workpoint 16.6 (page 177)
• Complete SRQ # 3 (page 177)
• Complete DRQ (page 178)