2.2 - Aggregate demand (AD)

Question 1

What are the components of Aggregate Demand (AD)?

Answer 1

AD = C + I + G + (X - M)
Where:
C = Consumption
I = Investment
G = Government expenditure
X = Exports
M = Imports

Question 2

Which component of AD is usually the largest in most developed economies?

Answer 2

Consumption (C)

Question 3

What does the AD curve show?

Answer 3

The total demand for goods and services in an economy at various price levels over a period of time.

Question 4

What causes a movement along the AD curve?

Answer 4

A change in the price level.

Question 5

What causes a shift of the AD curve?

Answer 5

A change in any component of AD (C, I, G, X-M), excluding the price level.

Question 6

Disposable Income

Answer 6

Income available to households after taxes and benefits.

Question 7

How does disposable income affect consumption?

Answer 7

Higher disposable income generally leads to higher consumption.

Question 8

What is the relationship between saving and consumption?

Answer 8

They are inversely related — when households save more, they consume less.

Question 9

How do interest rates affect consumption?

Answer 9

• Higher interest rates discourage borrowing and reduce consumption.
  *Lower interest rates encourage spending.

Question 10

Consumer confidence

Answer 10

A measure of how optimistic households are about their future income and the economy.

Question 11

Wealth effect

Answer 11

When people feel wealthier due to rising asset prices (e.g., house prices), they may spend more.

Question 12

Gross investment

Answer 12

The amount that a firm invests in business assets that does not account for depreciation.

Question 13

Net investment

Answer 13

gross investment minus depreciation

Question 14

6 influences on investment

Answer 14

1. Rate of economic growth
2. Business expectations and confidence.
3. Demands for exports.
4. Interest rates
5. Access to credit.
6. Influence of government and regulations.

Question 15

How does economic growth influence investment?

Answer 15

Higher growth encourages businesses to invest due to higher expected returns.

Question 16

What role do business expectations and confidence play in investment?

Answer 16

High confidence increases investment; uncertainty reduces it.

Question 17

How does demand for exports influence investment?

Answer 17

Higher export demand may lead to more investment in production capacity.

Question 18

What is the effect of interest rates on investment?

Answer 18

Lower interest rates reduce the cost of borrowing and encourage investment.

Question 19

How does access to credit affect investment?

Answer 19

If firms cannot borrow due to tight credit markets, investment is reduced.

Question 20

What is the role of government and regulation in investment decisions?

Answer 20

Supportive policies and low regulation can encourage investment; uncertainty and heavy regulation can deter it.

Question 21

What did Keynes mean by ‘animal spirits’?

Answer 21

The instinctive, emotional factors that influence business decision-making.

Question 22

The ………… is when economic growth is fast, and it could be inflationary or unsustainable.

Answer 22

boom

Question 23

During ……………., real output in the economy falls, and there is negative economic growth

Answer 23

recessions

Question 24

The economy goes through periods of booms and ………..

Answer 24

busts

Question 25

What influences government spending levels?

Answer 25

* The trade cycle (e.g. recession = more spending) * Fiscal policy decisions (tax and spend policies)

Question 26

How does the trade cycle affect government expenditure?

Answer 26

* During a recession, the government may increase spending to stimulate demand (e.g., on infrastructure projects or benefits). * During a boom, the government may reduce spending or run surpluses.

Question 27

Fiscal policy

Answer 27

Fiscal policy is the use of government spending and taxation to influence the economy.

Question 28

Current government expenditure

Answer 28

Day-to-day expenses (e.g., public sector wages, NHS services).

Question 29

Capital government expenditure

Answer 29

Investment in infrastructure and long-term assets (e.g., roads, schools).

Question 30

What are some limitations on government spending?

Answer 30

* Budget deficits and national debt * Political considerations * Tax revenues * International obligations (e.g. EU/IMF rules)

Question 31

Net trade

Answer 31

Exports (X) minus Imports (M). A positive value = surplus, a negative = deficit.

Question 32

What are the main influences on the net trade balances?

Answer 32

* Real income * exchange rates * State of the world economy * Degree of protectionism on-price factors

Question 33

How does real income affect net trade?

Answer 33

Higher income may lead to more imports, reducing net trade.

Question 34

What is the effect of exchange rates on net trade?

Answer 34

* A weaker currency makes exports cheaper and imports more expensive (improves net trade). * A stronger currency has the opposite effect.

Question 35

How does the state of the world economy influence UK net trade?

Answer 35

Strong global demand boosts UK exports, improving net trade.

Question 36

What does protectionism mean, and how does it affect trade?

Answer 36

Government-imposed trade barriers (e.g., tariffs) that can restrict imports and protect domestic industries.

Question 37

What are non-price factors affecting trade?

Answer 37

Product quality, reliability, branding, and delivery speed — all influence competitiveness regardless of price.