2.2 Aggregate Demand

Question 1

What is the AD equation?

Answer 1

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

Question 2

What % of AD does consumption make up?

Answer 2

60%

Question 3

What % of AD does investment make up?

Answer 3

15-20%

Question 4

What % of AD does net exports make up?

Answer 4

5%

Question 5

What % of AD does government spending make up?

Answer 5

18-20% of GDP
Around 20% AD

Question 6

What is the income effect?

Answer 6

Rise in prices not immediately matched by rise in income. Therefore, contraction in AD

Question 7

What is the substitution effect?

Answer 7

If prices in UK rise, less foreigners want to buy UK goods & more UK consumers will buy imported goods. Net imports cause contraction of AD

Question 8

What is the real balance effect?

Answer 8

Rise in prices will mean that savings are worth less - increasing MPS, contracting AD.

Question 9

What is the interest rate effect?

Answer 9

Rising prices means firms have to pay workers more. If supply stays the same then interest rates will rise, increasing saving and reducing consumption

Question 10

What is Disposable income (Y)?

Answer 10

Amount of income consumers have less after taxes and welfare payments

Question 11

What factors affect consumption?

Answer 11

Disposable income
Marginal Propensity to Consume

Question 12

How does income affect MPC?

Answer 12

Poorer people tend to have a higher MPC as they are likely to spend more of their increase in income whereas richer people tend to save it

Question 13

How do you calculate MPC?

Answer 13

Change in consumption / change in income

Question 14

How do you calculate MPS?

Answer 14

Change in savings/change in income

Question 15

What are factors that influence consumer spending?

Answer 15

Interest rates
Consumer confidence
Wealth Effects

Question 16

How do interest rates affect consumer spending?

Answer 16

Lower interest rates = more borrowing & less saving

Question 17

How does consumer confidence affect consumer spending?

Answer 17

If people are confident about future and expect pay rises then they will spend more, due to the expectation of inflation and higher prices

Question 18

How do wealth effects affect spending?

Answer 18

Wealth effect refers to those who have more value in assets spending more. Wealth effect experienced when house prices rise, so more confident in spending.

Question 19

What’s the difference between gross investment and net investment?

Answer 19

Gross investment is level of investment carried out
Net investment is the gross investment - level of depreciation
(UK depreciation accounts for 75% of gross investment)

Question 20

How does the rate of economic growth affect investment?

Answer 20

More growth = more investment as businesses more confident investment will return rewards. More demand = higher return rate

Question 21

What is the accelerator theory?

Answer 21

Investment over a period of time is the change in real income x capital - output ratio

Question 22

How does business confidence affect investment?

Answer 22

If businesses expect growth then they will want to invest so that they are prepared for the future

Question 23

How does demand for exports affect investment?

Answer 23

If world economy is booming, demand for exports will increase and therefore investment for exporting firms is likely to increase.

Question 24

How do interest rates affect investment?

Answer 24

High interest rates means that borrowing is more expensive so firms need to be more confident their investment will provide a return

Question 25

How does access to credit affect investment?

Answer 25

If banks less willing to lend then firms will find it harder to gain access to credit, so more expensive to gain funds for investment

Question 26

How does the government and regulations affect investment?

Answer 26

Lower corporation tax means firms keep more profit, encouraging more investment as shareholders more confident on return in investment High regs would also discourage investment

Question 27

How may gov spending be affected by a recession?

Answer 27

Gov spending may increase to try and boost the economy, e.g welfare payments.

Question 28

How may gov spending be affected by a boom?

Answer 28

Gov will spend less due to less need for economic stimulation. Also gain more in tax revenue

Question 29

What is discretionary fiscal policy?

Answer 29

Policy implemented through a one off change

Question 30

What are automatic stabilisers?

Answer 30

Policies offset by economic cycle, do not need implementation.

Question 31

What is expansionary fiscal policy?

Answer 31

More spending and less taxation during economic decline

Question 32

What is contractionary fiscal policy?

Answer 32

Reduction of gov spending and increase in taxes during a boom.

Question 33

How do real incomes affect trade balance?

Answer 33

Higher incomes usually mean more spending on imports

Question 34

How do exchange rates affect trade balance?

Answer 34

SPICED, but depends on ped of goods

Question 35

How will the state of the global economy affect the trade balance?

Answer 35

Fall in an export market will lead to less exports

Question 36

How does the degree of protectionism affect the trade balance?

Answer 36

Trade deficit will reduce with tariffs etc, however could lead to retaliation

Question 37

How might non price factors affect the trade balance?

Answer 37

Competitiveness of goods and services impacts e.g better quality, innovation etc