Aggregate Demand – Consumption (C) and Savings (S)

Question 1

What is the formula of AD?

Answer 1

AD = C + I + G + X – M

Question 2

What is consumption?

Answer 2

consumer spending on real output; spending on non-durables, durables & services; the largest component of AD, usually about 60%

Question 3

What is investment?

Answer 3

spending on capital goods; spending on plant, equipment etc. That help produce more consumer goods in future; investment demand comes from both private and public sector

Question 4

What is government spending?

Answer 4

spending by the government on its current day-to-day provision of public services such as healthcare, education, defence and transport. Does not include transfer payments (pensions and welfare benefits)

Question 5

What is Net trade (export demand X - import demand M)?

Answer 5

exports X are an inflow of demand from citizens abroad (inflow); imports M refers to domestic demand for foreign-produced goods (outflow).

Question 6

What are factors influencing consumption?

Answer 6

• Income
• Wealth effect
• Consumer confidence
• Job security
• Interest rates
• Demography

Question 7

How does income affect consumption?

Answer 7

especially real disposable income; typically more income means more consumer spending.

Question 8

How does wealth effect affect consumption?

Answer 8

an increase in the value of assets (property, shares etc.) encourages more consumer spending through a positive wealth effect

Question 9

How does consumer confidence affect consumption?

Answer 9

high confidence leads to more consumer spending

Question 10

How does job security affect consumption?

Answer 10

low unemployment can make people less worried they may lose their job and so they spend more.

Question 11

How does interest rates affect consumption?

Answer 11

affect the cost of borrowing; spending on big ticket items such as houses, cars and white goods are likely to rise when interest rates fall.

Question 12

How do demographics affect consumption?

Answer 12

a growing population (e.g. immigration) spending more
(And vice versa for factors causing a fall in consumption).

Question 13

What are benefits of rising consumption?

Answer 13

Rising AD
Faster short run economic growth
Less spare capacity
Falling unemployment
Gives businesses confidence to invest

Question 14

What are costs of rising consumption?

Answer 14

Inflation pressure
Current account deficit (more imports sucked in)
Unbalanced growth
More household debt
Could be bad for environment

Question 15

What is saving?

Answer 15

Saving (S) is NOT a component of AD, but disposable income that is not spent is saved.

Question 16

What is the savings ratio?

Answer 16

Question 17

What is the importance of saving for an economy?

Answer 17

Savings flow into financial markets and businesses can access these funds to invest
Savings provide households with a cushion of financial stability and funds for the government when it needs to borrow.

Question 18

What is the paradox of thrift?

Answer 18

The Keynesian paradox of thrift is an economic theory which states that an increase in saving can lead to a decrease in economic activity and, ironically, a decrease in overall saving.