Unit 2 & 4: Aggregate Demand - Revision Notes (with Links)

Updated revision notes on aggregate demand - there are several links for you to research further. Essential for Unit 2 & a really good refresher for Unit 4 students.
Aggregate demand(AD) = total spending on goods and services

AD = C + I + G + (X-M)

C: Consumers' expenditure on goods and services: Also known as consumption, this includes demand for durables e.g. audio-visual equipment and vehicles & non-durable goods such as food and drinks which are “consumed” and must be re-purchased.

I: Capital Investment – This is spending on capital goods such as plant and equipment and new buildings to produce more consumer goods in the future. Investment includes spending on working capital such as stocks of finished and semi-finished goods.

Capital investment spending in the UK accounts for between 15-20% of GDP in any given year. Of this investment, 75% comes from private sector businesses such as Tesco, British Airways and British Petroleum and the remainder is spent by the government – for example building new schools or in improving rail or road networks. Investment has important effects on the supply-side as well as being an important component of AD. A small part of investment spending is the change in the value of stocks. Producers may find either than demand is running higher than output (i.e. stocks will fall) or that demand is weaker than expected and below current output (in which case the value of stocks will rise.)

G: Government Spending – This is spending on state-provided goods and services including public goods and merit goods. Decisions on how much the government will spend each year are affected by developments in the economy and the political priorities of the government.

Government spending on goods and services is around 18-20% of GDP but this tends to understate the true size of the government sector in the economy. Firstly some spending is on investment and a sizeable amount goes on welfare state payments. Transfer payments in the form of benefits (e.g. state pensions and the job-seekers allowance) are not included in current government spending because they are a transfer from one group (i.e. people paying income taxes) to another (i.e. pensioners drawing their state pension having retired, or families on low incomes).

X: Exports of goods and services - Exports sold overseas are an inflow of demand (an injection) into our circular flow of income and spending adding to aggregate demand.

M: Imports of goods and services. Imports are a withdrawal of demand (a leakage) from the circular flow of income and spending.

Net exports measure the value of exports minus the value of imports. When net exports are positive, there is a trade surplus (adding to AD); when net exports are negative, there is a trade deficit (reducing AD). The UK has been running a large trade deficit for several years now.

The main components of aggregate demand are shown in the table above

Remember that

AD = C + I + G + X – M

Shocks to aggregate demand

Many unexpected events cause changes in the level of demand, output and employment. These events are called “shocks”. Some of the causes of AD shocks are as follows:

1.A large rise or fall in the exchange rate – affecting export demand and second-round effects on output, employment, incomes and profits of businesses linked to export industries.

2.A recession in main trading partners which affects demand for exports of goods and services.

3.A slump in the housing market or a big change in share prices

4.An event such as the credit crunch (global financial crisis) – involving a fall in the amount of credit available for borrowing by households and businesses.

5.An unexpected cut or an unexpected rise in interest rates or change in government taxation and spending – for example deep cuts in government spending as part of fiscal austerity

These shocks will bring about a shift in the aggregate demand curve

Factors causing a shift in AD

Changes in Expectations

Current spending is affected by anticipated income and inflation

When confidence falls, we see an increase in saving and businesses postpone investment projects because of worries over weak demand and lower expected profits.

Changes in Monetary Policy – i.e. a change in interest rates

If interest rates fall – this lowers the cost of borrowing and the incentive to save, encouraging consumption & investment

There are time lags between changes in interest rates and changes in AD

Changes in Fiscal Policy

Fiscal Policy refers to changes in government spending, taxation and borrowing

The Government may increase its expenditure e.g. financed by a higher budget deficit - this directly increases AD

Income tax affects disposable income e.g. lower income tax raises disposable income and should boost consumption.

Economic events in the world economy

International factors such as the exchange rate and foreign income

A depreciation in a currency makes imports dearer and exports cheaper - the net result should be that UK AD rises

An increase in overseas incomes raises demand for exports. In contrast a recession in a major export market will lead to a fall in exports and an inward shift of aggregate demand.

Changes in household wealth

Changing share and property prices affect the level of wealth

Declining asset prices can hit confidence / a fall in expectations

Changes in the supply of credit

The availability of credit is vital for the smooth functioning of most modern economies

Many banks and other lenders are now more reluctant to lend

Interest rates on different loans have become more expensive

Extension Reading for Contextual Knowledge

Here is a selection of articles for extension / enrichment reading on this topic

UK house prices see annual growth, Nationwide says - how might a recovery in house prices affect the different components of aggregate demand?

Budget 2013: Infrastructure spending boosted by £3bn a year - will this expansion in investment spending be sufficient?

Britain, the world and the end of the free lunch? - Britain's trade deficit increased in 2012, what does this mean for aggregate demand and prospects of a stronger recovery from recession?

Unit 4: FDI in Africa

Below is a concise yet comprehensive set of notes on advantages of FDI and its issues...a MUST read for Y13 students. This will really help with any case study or essay on development and FDI.

The specific focus is on foreign direct investment in Africa and how investment from China and other BRIC countries is helping or nindering development.


Foreign direct investment comes in different forms

•Merger and takeover activity

•Land purchases by overseas investors – known as land grabs

•Fixed capital investment involving building new factories, assembly plants and distribution centres

Motivations for foreign direct investment

The main motivations for the expansion of multinational activity are as follows:

1.Higher profits and a stronger position and market access in global markets

2.Reduced technological barriers to movement of goods, services and factors of production

3.Cost considerations – a desire to shift production to countries with lower unit labour costs

4.Forward vertical integration (e.g. establishing production platforms in low cost countries where intermediate products can be made into finished products at lower cost)

5.Avoidance of transportation costs and tariff and non-tariff barriers

6.Extending product life-cycles by producing and marketing products in new countries

7.The urge to merge – the financial incentives created by the global deregulation of capital markets is making it easier to achieve acquisitions and mergers and thereby encouraging the external growth of a business.

China in Africa - Evaluating Benefits and Costs for Africa

Partly because of persistent trade surpluses with many other parts of the world, China has accumulated foreign-exchange reserves in excess of $3 trillion. These surpluses allow for huge levels of overseas direct investment – much of the current focus is on China’s investments in many African and Latin American countries. The media often portray such investment in highly simplistic terms – accusing the Chinese of land-grabbing, resource-snatching, and neo-colonialism. The reality is much more complex.

We have seen large Chinese investments in Africa and hundreds of thousands of Chinese are now living and working in Africa – this is now major source of remittance income back to domestic Chinese economy. In recent years China has given more loans to poor countries than the World Bank. In African countries such as Nigeria and Zambia, amounts from China of over US$100 million per year have been the norm over the past few years. In Zambia, for instance, this has represented 1–1½ percent of GDP.”

Debunking the myths of china from MoTanweer

Benefits of Chinese FDI for Africa


1.FDI has boosted growth – with recent growth rates in Sub-Saharan Africa of more than 8% - substantial progress has been made in reducing extreme poverty

2.FDI has accelerated investment in new infrastructure. For example, the Addis Ababa – Djibouti road; provides coastal access for land-locked Ethiopia. Other projects include dams and airports, mines and wind farms providing opportunities for African nations to grow capacity in renewable energy.

3.Africa is endowed with significant natural advantages – it is the best continent for solar/bio-fuel. Africa cannot wait 5-10 years for these technologies to improve: energy investment is needed now and FDI provides the key to achieving this

4.Imported cheaper goods from China raises real incomes for an emerging African middle class

5.Investment is linked to better training for local workers, an improvement in human capital

6.Chinese investment in fertile but underdeveloped farmland in Africa will raise farm productivity and incomes whilst helping to keep down world food prices – benefitting millions of the poorest people

7.Open bidding for investment contracts is an opportunity for African businesses

8.Chinese investment in Africa has been mixed: 29% mining, 22% manufacturing, 15% construction, 14% finance, 19% other – mostly not resource depletive activities; FDI into Africa does create jobs (China does not exclusively bring in Chinese workers unless locals are unavailable; e.g. building a graduate college in Ethiopia to train engineers for construction projects)

9.China historically has operated in a self-interested way, not expansionary/colonial. For FDI to work in the long run, the benefits have to be mutual. FDI from China to Africa is not that large - only 5% of Africa inwards FDI comes from China; only 3% of Chinese investment is to Africa

10.Many African governments prefer to borrow from China rather than depend conditional lending by the World Bank and the IMF - loans from China’s Exim bank to Africa in 2011 were double that of the World Bank, cementing a trend which started around 2005.



Costs / Risks of Chinese FDI for Africa


1.Inward migration of Chinese workers has limited the employment-creation effects for African nations

2.There are fears that Chinese FDI will accelerate the process of natural resource depletion for African countries relying heavily on these resources as a source of income and wealth.

3.Some economists argue that Chinese companies have set up in Africa as a route to get their products into the USA – thereby avoiding US tariffs and other import controls on Chinese manufactured products

4.Many African countries have a limited domestic manufacturing base unable to compete effectively with the arrival of Chinese competition.

5.Fears of a loss of control over economies, remittance of profits and wages back to China and the risk of foreign takeovers

6.It was estimated in 2011 found that over 1 million Chinese migrants were living and working in Africa, often connected to Chinese FDI projects. The Chinese Diaspora might be undermining entrepreneurship in many local communities in some African countries

7.Fears that the balance of economic power is firmly tilted in favour of the Chinese who can negotiate favourable terms for any investment projects.

8.Dangers of unsustainable natural resource depletion - fears about weak social and environmental responsibility from Chinese investors

Unit 4: The BRICS meet to aid development.

Click here to access a BBC article which discusses the latest meeting of the BRICS economies in South Africa. It was said that the BRICS wanted to create a 'Development' bank...however, this article by Al Jazeera states that the talks have not agreed to set up the bank.

Check out the Al Jazeera news clip from 27th March 2013



There are so many development issues here. Possible questions include:

Do the BRICS economies trust each other?
Why are they so interested in Africa?
Will Africa benefit from the (possible) infrastructure projects or will there be strings attached?
What do they have to gain to meet without the powers of EU & USA?

Unit 1: Price Elasticity of Demand

Hilarious....My brother trying to teach Economics.....(it's actually quite informative & useful for Y11 & Y12)....enjoy!!

Unit 2: Rebalancing the economy

"Rebalancing the economy - it has become a mantra in Whitehall, the Bank of England and the world of economic think tanks." But why? 

It is up to you Year 12 to investigate!

In your research you need to find out what is going on with the UK's Current Account Balance of Payments, why a deficit might be a problem and how it can be solved. What does George Osborne think needs to be done?

Look here for more information...

Here and here 

http://www.cbi.org.uk/media/1231301/cbi_rebalancing_the_economy_report_301211.pdf

Unit 2 & 4: Keynesian stimulus can reduce govt debt

Increasing taxes during an economic crisis makes perfect sense!

Thank you to Mr Drennan for spotting this recent Guardian article focusing on debt-friendly stimulus rather than austerity. It suggests that citizens do not necessarily have to endure further financial hardship. Excellent for students discussing macroeconomic policy in their essays.

(Source: guardian.co.uk, Thursday 21 March 2013)

Raising taxes means more government expenditure on projects such as road-building, which directly benefits the public. Photograph: Bob Battersby/Eye Ubiquitous/

With much of the global economy apparently trapped in a long and painful austerity-induced slump, it is time to admit that the trap is entirely of our own making. We have constructed it from unfortunate habits of thought about how to handle spiralling public debt.

People developed these habits on the basis of the experiences of their families and friends: when in debt trouble, one must cut spending and pass through a period of austerity until the burden (debt relative to income) is reduced. That means no meals out for a while, no new cars and no new clothes. It seems like common sense – even moral virtue – to respond this way.

But, while that approach to debt works well for a single household in trouble, it does not work well for an entire economy, as the spending cuts only worsen the problem. This is the paradox of thrift: belt-tightening causes people to lose their jobs, because other people are not buying what they produce, so their debt burden rises rather than falls.

There is a way out of this trap, but only if we tilt the discussion about how to lower the debt/GDP ratio away from austerity – higher taxes and lower spending – toward debt-friendly stimulus. This means further increasing taxes and raising government expenditure in the same proportion. That way, the debt/GDP ratio declines because the denominator (economic output) increases, not because the numerator (the total the government has borrowed) declines.

This kind of enlightened stimulus runs into strong prejudices. For starters, people tend to think of taxes as a loathsome infringement on their freedom, as if petty bureaucrats will inevitably squander the increased revenue on useless and ineffective government employees and programs. But the additional work done does not necessarily involve only government employees, and citizens can have a voice in how the expenditure is directed.

People also believe that tax increases cannot realistically be purely temporary expedients in an economic crisis, and that they must be regarded as an opening wedge that should be avoided at all costs. History shows, however, that tax increases, if expressly designated as temporary, are indeed reversed later. That is what happens after major wars, for example.

We need to consider such issues in trying to understand why, for example, Italian voters last month rejected the sober economist Mario Monti, who forced austerity on them, notably by raising property taxes. Italians are in the habit of thinking that tax increases go only to paying off rich investors, rather than to paying for government services such as better roads and schools.

Keynesian stimulus policy is habitually described as deficit spending, not tax-financed spending. Stimulus by tax cuts might almost seem to be built on deception. Its effect on consumption and investment expenditure seems to require individuals to forget that they will be taxed later for public spending today, when the government repays the debt with interest. If individuals were rational and well informed, they might conclude that they should not spend more, despite tax cuts, since the cuts are not real.

We do not need to rely on such tricks to stimulate the economy and reduce the ratio of debt to income. The fundamental economic problem that currently troubles much of the world is insufficient demand. Businesses are not investing enough in new plants and equipment. They are not adding jobs, largely because people are not spending enough – or are not expected to spend enough in the future – to keep the economy going at full tilt.

Debt-friendly stimulus might be regarded as nothing more than a collective decision by all of us to spend more to jump-start the economy. It has nothing to do with taking on debt or tricking people about future taxes. If left to individual decisions, people would not spend more on consumption. However, maybe we can vote for a government that will compel us all to do that collectively, thereby creating enough demand to put the economy on an even keel in short order.

Simply put, Keynesian stimulus does not necessarily entail more government debt, as popular discourse seems to assume. Rather, stimulus is about making collective decisions to get aggregate spending back on track. The spending naturally involves different kinds of consumption than we would make individually – say, better highways, rather than more dinners out. But that should be OK, especially if we all have jobs.

Balanced-budget stimulus was first advocated in the early 1940s by William Salant, an economist in president Franklin Roosevelt's administration, and by Paul Samuelson, then a young economics professor at the Massachusetts Institute of Technology. They argued that, because any government stimulus implies higher taxes sooner or later, the increase may as well come immediately. For the average person, the higher taxes do not mean lower after-tax income, because the stimulus will have the immediate effect of raising incomes. And no one is deceived.

Many believe that balanced-budget stimulus – tax increases at a time of economic distress – is politically impossible. After all, French president François Hollande retreated under immense political pressure from his campaign promises to implement debt-friendly stimulus. But, given the shortage of good alternatives, we must not assume that bad habits of thought can never be broken, and we should keep the possibility of more enlightened policy constantly in mind.

Some form of debt-friendly stimulus might ultimately appeal to voters if they could be convinced that raising taxes does not necessarily mean hardship or increased centralisation of decision-making. When people understand that it means the same average level of take-home pay after taxes, plus more jobs and products of additional government expenditure (such as new roads), they may well wonder why they ever tried stimulus any other way.

Unit 2: Balance of Payments

I know this is poor blogging Mr Bentley! Just links to look at.. better blogging to follow!!

http://www.tutor2u.net/economics/revision-notes/as-macro-balance-of-payments.html

http://www.cbi.org.uk/media/1231301/cbi_rebalancing_the_economy_report_301211.pdf

http://brynsaseconomicsblog.blogspot.ae/search/label/Balance%20of%20Payments