Topic 1.2 - Aggregate Demand

Question 1

What is aggregate demand?

Answer 1

Total demand for goods and services produced in an economy at a given price level, in a given time period

Question 2

What are the components of AD?

Answer 2

C + I + G + ( X - M)

Question 3

What is consumption?

Answer 3

Spending by households on domestic goods and services

Question 4

What influences how much households spend?

Answer 4

Real disposable income
Wealth
Consumer confidence and expectations
Rate of Interest
Age structure of population
Distribution of income
Inflation

Question 5

What influences how much households spend? Real disposable income

Answer 5

As real income rises, households and economies tend to spend more
However, some may be saved
Average UK disposable income = £25,000

Question 6

What influences how much households spend? Wealth

Answer 6

Value of assets a household holds, stock of accumulated past savings (property)
Higher household wealth = more spending
Can be spent and used to borrow against
Results in greater consumer confidence

Question 7

What influences how much households spend? Consumer confidence and expectations

Answer 7

Optimistic feeling about jobs and wages leads to increased spending
Important link to house prices - rising house prices generally lead to encourage consumer spending

Question 8

What influences how much households spend? Rate of Interest

Answer 8

Consumption financed through borrowing
Fall in R.O.I usually associated with rise in consumer expenditure - cheaper to borrow, reduces incentive to save, more to spend when paying less interest.

Question 9

What influences how much households spend? Age structure of population

Answer 9

Young and elderly spend a relatively high proportion of their income

Question 10

What influences how much households spend? Distribution of income

Answer 10

Poor spend more than rich

Income/wealth not evenly distributed

Question 11

What influences how much households spend? Inflation

Answer 11

Rising prices may cause people to hold off from current spending

Question 12

What is the consumption function?

Answer 12

Relationship between consumer expenditure and disposable income
Position depends on other factors that affect how much households spend on consumer expenditure

Question 13

Consumption function model

Answer 13

Question 14

Evaluate the relationship between consumption and income, on the one hand…

Answer 14

Yes there’s a clear relationship between income and consumption
As income increases so does consumption

Question 15

Evaluate the relationship between consumption and income, on the other hand…

Answer 15

Extent to which on increase in income will lead to an increase in consumption depends on proportion of additional income saved
Consumption often lower than increase in income, household may not respond to small change in income
Expectations and confidence in the future economy - will base spending on what will they expect will happen in future rather than current levels of income
Type of employment eg zero hours contracts - may be wary of any changes in income and increasing consumption due to flexible nature of contract
They may smooth out expenditure over a lifetime - borrow young, pay back when middle aged, save for retirement

Question 16

What is investment?

Answer 16

Spending by firms on capital goods
Man-made aid to production (adds to capital stock)
Allows increased output of consumer goods and services in future

Question 17

What is gross investment?

Answer 17

Total spent on capital

Question 18

What is net investment?

Answer 18

Total capital spending - capital consumption ( replacement investment )

Question 19

Why would a firm want to invest?

Answer 19

Higher profits from meeting higher demands
Expand capital stock to increase capacity
Improve efficiency through innovation/technological progress
Expand firm’s product range
Invest in new tech to remain competitive (international markets)

Question 20

Benefits of investment

Answer 20

Increase productive capacity of economy by increasing capital stock of capital available for production
Capital stock provide a supply of housing services over a long period of time

Question 21

What influences investment?

Answer 21

Rate of investment - lower rates mean cheaper borrowing, cheaper for firms to invest
Current profit levels - may use profit to invest
Expectations/confidence about future - confidence makes firms more likely to invest however, if inflation is high, increases uncertainty therefore reduces confidence/investment
Changes in Real disposable income - if income increases, firms invest to reach future demands
Advances in tech

Question 22

What is the importance of expectations for investment and consumption?

Answer 22

Expectations formed by households and firms
Pessimistic views could result in lower AD
Households may save more, firms invest less when uncertain about future AD
Could cause/lead to recession, expectations can be self - fulfilling - firms find they’re justified in not investing
However, if optimistic, demand may increase, firms would invest, productive capacity of economy increases

Question 23

What influences government spending?

Answer 23

Level of market failure and intervention
War, terrorist attacks, crime
Level of economic activity - unemployment/inflation
Political reasons - pleasing the electorate

Question 24

What is trade?

Answer 24

Selling and buying goods and services from other countries

Question 25

What are imports?

Answer 25

Purchase of good and services from abroad that leads to outflow of currency from the UK

Question 26

What are exports?

Answer 26

Sale of goods and services to buyers from other countries leading to an inflow of currency to the UK

Question 27

What factors influence the level of imports and exports?

Answer 27

Real disposable income at home
Real disposable income abroad
Domestic Price levels relative to price levels abroad
Exchange rates
Gov. Restrictions on free trade

Question 28

Real disposable income at home - factor influencing level of imports and exports

Answer 28

Increased real disposable income will increase demand for imports
Decreased real disposable income will decrease demand for imports

Question 29

Real disposable income abroad - factor influencing level of imports and exports

Answer 29

Demand for exports depends on UK trading partners
If there’s slow economic growth in trading countries, less will be exported so will impact AD in the UK
If there’s fast economic growth in trading countries, more will be exported

Question 30

Domestic price levels relative to price levels abroad - factor influencing level of imports and exports

Answer 30

If UK inflation is high, exports will fall for UK and demand for imports will rise
If inflation is low, demand for exports will rise and demand for imports will fall

Question 31

Exchange rates - factor influencing level of imports and exports

Answer 31

Increased UK exchange rate will increase demand for imports and decrease demand for exports
( weaker £ can sell more exports, stronger £ buys more imports )

Question 32

Gov. Restrictions on free trade - factor influencing level of imports and exports

Answer 32

Increased restrictions such as tariffs would impact level of exports or imports

Question 33

Aggregate demand curve definition and diagram

Answer 33

Relationship between level of AD and overall price level - shows planned expenditure at any given overall price level

Question 34

What causes a movement along the curve?

Answer 34

Change in price level

Question 35

What causes the curve to shift?

Answer 35

Changes in AD components (C + I + G + (X - M))

Question 36

What will the effect be of the following on AD:

• households + firms more optimistic about economic prospects
• cut in income tax
• rise in interest rate
• fall in exchange rate
• rise in population size

Answer 36

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