“c02DomesticMacroeconomicGoals_PrintPDF” — 2022/7/23 — 6:51 — page 129 — #29
Interest rates can affect aggregate demand
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Budgetary policy can affect aggregate demand
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Interest rates are the cost of borrowing money (credit). Along with other factors, they are influenced by the Reserve Bank of Australia (RBA) and are part of its monetary policy. This policy is designed to affect the growth in credit-sensitive C (on consumer durables) and I spending (on the purchase of new equipment and the expansion of businesses). As a consequence, interest rates are seen as an aggregate demand factor affecting GDP, employment and income levels. After a time lag, a rise in interest rates tends to slow C and I, thus weakening AD and domestic economic activity, while a reduction in interest rates tends to eventually accelerate AD and GDP growth.
Business confidence or expectations relate to the level of optimism or pessimism by a firm about its future sales and profits. It affects the level of business investment spending. Interest rates represent the cost or price of borrowing credit or incentive to save, expressed as a percentage. Terms of trade is an aggregate demand factor. It represents the ratio of the average prices we receive for our exports relative to the average prices we pay for imports of goods. A rise in Australia’s terms of trade is said to be favourable because the world is prepared to pay us higher unit prices for our exports relative to the prices we pay for imports. This tends to increase the value of exports relative to imports, thereby increasing net injections and AD. Put another way, a rise in our terms of trade means that a given unit of exports will pay for a greater quantity of imports.
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Business confidence or expectations has to do with whether firms are generally feeling optimistic or pessimistic about their level of future sales and profits. Business confidence is an aggregate demand factor because it affects the level of business investment spending (I) on new plant and equipment. If firms are optimistic and expect higher future sales and profits, after a time lag they lift I in order to help expand their productive capacity. Here, their spending tends to accelerate AD and economic activity. By contrast, the reverse occurs if business pessimism sets in.
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Business confidence can affect aggregate demand
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Budgetary policy relates to changes in expected government receipts from taxes and outlays on goods and services for the upcoming year. Clearly, tax rates, outlays on welfare, industry assistance for exporters and spending on public goods like education, health or defence, can affect AD by influencing levels of C, I, G1 , G2 , X and even M. We will see that whether the government runs a budget surplus (where the value of tax and other receipts exceeds outlays) or a budget deficit (where the value of its outlays exceeds its receipts) depends on many things, especially domestic macroeconomic conditions (i.e. whether the level of economic activity is weak or strong). A surplus tends to slow AD, while a deficit provides stimulus to spending.
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Economic activity overseas can affect aggregate demand
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Economic activity overseas among our trading partners involves the general pace of production in countries including Japan, the United States, New Zealand and China, and whether these nations are experiencing a period of boom or recession. This is an aggregate demand factor that alters the level of overseas spending on our X (exports of locally made commodities, services and manufactured goods), and may possibly influence levels of foreign I. After a time lag, a downturn in activity overseas usually means weaker X sales (lower injections) and AD in Australia, thereby slowing domestic economic activity. However, the reverse applies if activity abroad rises. The terms of trade can affect aggregate demand
The terms of trade measures the ratio of the average prices the world is prepared to pay us for our exports against the average price we pay the world for our imports. It is regarded as an aggregate demand factor because the prices we receive or pay in international transactions affect the value of our exports or injections against TOPIC 2 Domestic macroeconomic goals
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