2.2.1-5 Aggregate Demand and Components

Question 1

Define Aggregate Demand

Answer 1

The total amount of spending on goods or services in a period of time

Question 2

Identify the components of AD

Answer 2

C+I+G+(X-M) Consumption + Investment + Government Spending + (Exports - Imports)

Question 3

How significant are the components of AD?

Answer 3

Consumption is the most significant with 65%, Investment has a further 15%, Government Spending has 15-20%, and the remainder is Exports and Imports

Question 4

What does an AD curve show?

Answer 4

It shows the relation between the general price level and income. It shows the amount of goods that will be consumed at a specific price.

Question 5

Why is an AD curve sloping?

Answer 5

1) The wealth effect- as the price level rises the income level decreases so less can be consumed
2) The interest rate effect- as price level rises, income falls meaning people are less likely to save. As savings decrease the funding for investment decreases, pushing up the interest rate. As investment is a component of AD this means that spending falls too
3) The exchange rate effect- As prices rise in the UK exports look less competitive compared to foreign goods causing exports to fall and imports to rise. As net X-M is a component of AD which is decreasing this causes spending to decrease

Question 6

What would cause a movement along the AD curve?

Answer 6

An increase in price level is the only thing that causes a contraction or expansion in the price level.

Question 7

What would cause a shift in the AD curve?

Answer 7

A change that effects any or all of the components of AD or the demand in the economy

Question 8

Name 5 factors that would affect consumption

Answer 8

Real income rising, Interest rates, Job security, Asset prices, Personal tax falling

Question 9

Define Investment

Answer 9

Investment is the purchase of fixed capital such as machinery

Question 10

What is a depreciation of capital?

Answer 10

This is where the value of the machine, for example, will decrease over time as it is used more and ages

Question 11

Distinguish between investment and net investment

Answer 11

Capital needs to be replaced otherwise the value of stock will decrease due to depreciation. Net investment is the investment over and above the investment needed to replace old capital.

Question 12

Name 7 factors that will increase investment

Answer 12

—› Low interest rates
—› Animal Spirits
—› Demand for exports rise 
—› Access to credit improves
—› Lower tax and business regulations
—› A high rate of economic growth 
—› Business expectations and confidence

Question 13

Define Government expenditure

Answer 13

This refers to the government purchasing goods and services, I.e. NHS, public services

Question 14

Distinguish between government spending and government expenditure

Answer 14

Government spending includes things such as welfare payments and pensions which are included in consumption not Government Expenditure.

Question 15

Define fiscal policies

Answer 15

Fiscal Policy is government spending and taxation.

Question 16

Name 3 fiscal policies

Answer 16

• VAT tax increasing
• Income tax falling
• Corporation tax falling

Question 17

What is meant by budget deficit?

Answer 17

When government spending › Taxation

Question 18

How does the trade cycle affect Government expenditure?

Answer 18

In a recession government spending will increase as there are more people claiming JSA due to the increased rate of unemployment. This is because business are not maximising their output meaning they don’t need as many employees and are unable to pay their wages forcing them to let some of their worker go.

Question 19

Define Exports

Answer 19

Exports are the goods sold from the UK to foreign companies. Currency flows into the UK

Question 20

Define Imports

Answer 20

Imports are all the goods purchased by the UK from foreign companies. Currency flows out of the UK

Question 21

What is meant by Net Exports?

Answer 21

When X›M

Question 22

Define Exchange Rate

Answer 22

The exchange rate is the value of one currency for the purpose of conversion to another.

Question 23

Explain the affect on the current account in the sterling exchange rate

Answer 23

If there is a strong pound then the price of imports are lower as the UK is able to buy more for their money however it causes exports to be more expensive, making them less competitive. Overall, this will result in a current account deficit as M›X.

Question 24

How does domestic inflation affect net exports?

Answer 24

Prices will rise domestically which makes exports less competitive resulting in net exports to decrease.

Question 25

How does a global recession affect net exports?

Answer 25

A global recession would cause most countries to source their products domestically causing net exports to decrease.

Question 26

How does the domestic business cycle affect net imports?

Answer 26

During a UK recession the UK will source their goods internally as imports would be more expensive. Therefore causing imports to fall.

Question 27

What is meant by protectionism and give examples?

Answer 27

Protectionism is when a country uses barriers to trade to protect domestic industries i.e. tariffs and quotas