4.2.2.2, 4.2.2.3, 4.2.2.4 Aggregate Demand

Question 1

AD Equation

Answer 1

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

Question 2

Components of AD

Answer 2

• Consumption
• Investment
• Government Spending
• Exports
• Imports

Question 3

Consumption Definition

Answer 3

Spending on goods and services.

Question 4

Investment Definition

Answer 4

• Gross Domestic Fixed Capital Formation
• Spending on assets used over a number of years to produce goods and services.
• Includes spending on capital goods (machinery and vehicles) and on working capital (stocks of finished goods and work in progress).
• Net investment includes depreciation. Gross investment doesn’t.

Question 5

Government Spending Definition

Answer 5

Spending on publicly provided goods and services.

Question 6

Exports Definition

Answer 6

UK output sold abroad.

Question 7

Imports Definition

Answer 7

Foreign output purchased by the UK.

Question 8

Proportions of AD

Answer 8

Consumption - 61%
Government Spending - 25%
Investment - 15%
Net Exports - -1%

Question 9

Axes on AD Curve

Answer 9

Y Axis - Price Level
X Axis - Real National Output

Question 10

Price Level Definition

Answer 10

The average of prices for all goods and services in an economy i.e. inflation.

Question 11

Real National Output Definition

Answer 11

The output of the economy taking into account inflation.

Question 12

Real Balance Effect Definition

Answer 12

As P level rises, the real value of incomes falls = consumers, government, business less able to buy what they want or need.

Question 13

Factors Affecting Consumption

Answer 13

1. Disposable Income and Saving:
   - Marginal Propensity to Consume.
   - Marginal Propensity to Save.
   - Average Propensity to Consume.
   - Average Propensity to Save.
2. Consumer Confidence.
3. Interest Rates and the supply of credit.
4. Distribution of Income.
5. Actual changes in the economy.

Question 14

Marginal Propensity to Consume Definition

Answer 14

The amount of an increase in earnings that is spent.

Question 15

Marginal Propensity to Save Definition

Answer 15

The amount of an increase in earnings that is saved.

Question 16

Consumer Confidence Definition

Answer 16

Influenced by employment security, real disposable income, household wealth, the likelihood of the population to inject into the circular flow of income.

Question 17

Supply of Credit Definition

Answer 17

How easy it is to get a loan/credit card.

Question 18

Factors Affecting Levels of Investment

Answer 18

1. Actual and Expected Demand.
2. Demand for Exports.
3. Interest Rates.
4. Risk.
5. Marginal Efficiency of Capital.
6. Technological Change and Competitiveness.
7. Business Confidence.
8. Bank Willingness to Lend.
9. Government Policy towards investment/business including Corporation tax.
10. Accelerator Effect.

Question 19

Marginal Efficiency of Capital Definition

Answer 19

The expected return on an investment at a given time.

Question 20

Business Confidence Definition

Answer 20

‘Animal Spirits’ is a notion devised by Keynes referring to when, if firms are more confident, they will invest more upon gut instinct. Also, if others are investing, then the firm is more likely to.

Question 21

Accelerator Effect Definition

Answer 21

An increase in national income results in a proportionally larger change in investment.

Question 22

Factors Affecting Government Spending

Answer 22

1. Policy Commitments (use of Fiscal Policy to achieve objectives).
2. The Government in power at the time.
3. Stage in business cycle.

Question 23

Factors Affecting Net Trade

Answer 23

1. Level of Real Income - Real income increase leads to a rise in imports, may increase exports.
2. Exchange Rate - SPICED (Strong Pound Imports Cheaper Exports Dearer)
3. Quality and other non-price factors.
4. Economic performance of other countries.
5. Protectionism - (MAGA - Trump’s tariffs on Imports.

Question 24

Aggregate Demand Side Shocks

Answer 24

1. Recession in one or more of our trading partners.
2. A big rise or fall in the exchange rate.
3. Housing market slumps.
4. Share price collapses.
5. Events e.g. Financial Crisis/credit crunch.
6. Unexpected cuts or rises in interest rates and tax.

Question 25

Multiplier Effect Definition

Answer 25

When an initial injection into the circular flow causes a bigger final increase in national income.

Question 26

Multiplier Effect Equations

Answer 26

1/1-MPC 1/MPS + MPT + MPM 1/MPW

Question 27

Marginal Propensity to Consume Equation

Answer 27

Change in Consumption/Change in Income

Question 28

Factors that reduce the size of the Multiplier

Answer 28

1. Savings. 2. Taxes. 3. Imports.

Question 29

Marginal propensity of Withdrawals Components

Answer 29

1. Marginal Propensity to Save. 2. Marginal Propensity to Tax. 3. Marginal Propensity to Import.

Question 30

Marginal Propensity to Save Definition

Answer 30

Measures the proportion of an increase in income is saved.

Question 31

Marginal Propensity to Tax Definition

Answer 31

Measures the proportion of an increase in income taken in tax.

Question 32

Marginal Propensity to Import Definition

Answer 32

The proportion of an increase in income spent on imports.

Question 33

Marginal propensity to withdraw calculation

Answer 33

MPW = MPS + MPT + MPM

Question 34

Factors Affecting the Size of the Multiplier

Answer 34

1. Interest Rates 2. Taxation Rates 3. Imports 4. Spare Capacity 5. Confidence 6. Income Levels

Question 35

How Interest Rates affect the Size of the Multiplier

Answer 35

If interest rates are high, then consumption may not rise significantly as additional income may be saved, which is a withdrawal from the circular flow of income and national income would not rise as much as anticipated.

Question 36

How Taxation Rates affect the Size of the Multiplier

Answer 36

If taxation rates are high then consumers will have less disposable income with which to consume goods and services.

Question 37

How Imports affect the Size of the Multiplier

Answer 37

- High propensity to consume imports in the UK. - If increases in disposable income, but this is spent on imports, then it counts as a withdrawal.

Question 38

How Spare Capacity affects the Size of the Multiplier

Answer 38

- If there is very little spare capacity, an increase in aggregate demand may not be able to be met by firms.

Question 39

How Confidence affects the Size of the Multiplier

Answer 39

High confidence will encourage people to spend, raising the MPC, whereas low confidence will lead to a lesser MPC and lower multiplier.

Question 40

How Income Levels affect the Size of the Multiplier

Answer 40

- If income levels are low, then MPC is likely to be quite high, whereas high income levels will likely lead to low MPC and high MPS.