Aggregate Demand

Question 1

What is the formula for Aggregate Demand?

Answer 1

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

Question 2

What is aggregate demand?

Answer 2

The total demand for goods and services within a specific market at a given price level. All relates to National Expenditure

Question 3

Consumption

Answer 3

Covers household spending on goods and services by consumers - 60% - 65% of AD

Question 4

Investment

Answer 4

Covers investment spending on fixed capital by firms (e.g., factory) and also working capital (purchases required to produce goods)

Question 5

Government Spending

Answer 5

Spending by the government on goods and services (e.g., NHS) - Doesn’t include transfer payments, benefits, tax credits

Question 6

What is net exports?

Answer 6

Known as net trade. All money earned from selling exports minus all money spent on imports

Question 7

What is the Price Level

Answer 7

Average of current prices across the entire spectrum of goods and services produced in an economy.

Question 8

Contraction and Expansion

Answer 8

Happens when price level changes (up or down)

Question 9

AD Shifts

Answer 9

Occurs when one of the components changes (left or right)

Question 10

Consumer Confidence

Answer 10

• Measures how consumers feel about the state of economies and their personal finances
• Measured using GFK
• Might not happen as consumers don’t have the perfect info about the economy.

Question 11

What happens when there is more demand for exports and interest rates drop?

Answer 11

At a lower price level, people are more likely to have more disposable income. If price level decreases, goods become more competitive so there are more exports. Exports are a component of AD, so AD will shift right. At a lower price level, interest rates usually fall so AD increases further

Question 12

Factors influencing consumption

Answer 12

1) Wealth Effect
2) Consumer Confidence
3) Income tax
4) Availability of Credit
5) Population
6) Interest rates
7) Inflation
8) Employment

Question 13

How does wealth effect impact consumption?

Answer 13

Increased wealth effect leads to more consumption as people are more confident

Question 14

How does consumer confidence impact consumption?

Answer 14

Increased consumer confidence means consumption increases as people feel the purchases are safer

Question 15

How do Income taxes impact consumption?

Answer 15

As income tax increases, consumption decreases as people have less disposable income

Question 16

How does availability of credit impact consumption?

Answer 16

Increased availability of credit increases consumption as people have increased spending power

Question 17

How does population impact consumption?

Answer 17

Increased population increases consumption as more products are needed

Question 18

How do interest rates impact consumption?

Answer 18

Increased interest rates decrease consumption as goods are more expensive and saving is more appealing

Question 19

How does inflation impact consumption?

Answer 19

Increased inflation decreases consumption as money now buys you less

Question 20

How does employment/income impact consumption?

Answer 20

Increased employment increases consumption as workforce increases so there’s more supply of goods and more salaries

Question 21

Definition of a recession?

Answer 21

When GDP falls for two consecutive quarters

Question 22

Impact on recessions on households and firms and government

Answer 22

Households - Less jobs
Firms - Less investment, dividends and wages for share holders. Also, less profitable with less jobs.
Government - Less money from taxes, so less spent on benefits, public services and government workers

Question 23

What is stagflation?

Answer 23

When the economy is struggling to grow whilst inflation increases rapidly

Question 24

What does the BOE do to help recover from a recession?

Answer 24

• Cuts interest rates, so cheaper for businesses and houses to borrow money. This leads to more spending and growth but also more inflation
• Quantitative Easing - Also leads to more inflation

Question 25

What is annuity?

Answer 25

It’s a fixed retirement income for the rest of your life which you can buy using some, or all, of the pension pot saved up whilst working.
They’re popular as bond yields have been rising

Question 26

Influences on government spending

Answer 26

1) Tax receipts
2) Fiscal policies (e.g., austerity measures)

Question 27

What happens to government spending during booms, recessions and depressions?

Answer 27

Booms - Government spending decreases (also make more from taxes). Less on benefits + transfer payments as more households are employed - LRAS shifts right
Recessions - Government spending increases (also make less from taxes). More on benefits + transfer payments as less households are employed - LRAS shifts left.
Depressions - Government spending decreases massively

Question 28

Government spending on transmission mechanisms practice question formatting

Answer 28

1) Falling economic growth -> GDP falls, go into recession -> more unemployment and benefits needed -> increased government spending
2) Increase in economic growth -> GDP increases, there’s a boom -> decreased unemployments and benefits needed -> decreased government spending
3) Falling economic growth -> Less consumption -> decreased GDP -> increased unemployment and benefit payments -> households earn less -> fall in receipts for government
4) Increase in economic growth - GDP increases -> consumer confidence increases -> consumption increases further -> employment increases -> less government spending (e.g., on welfare benefits and transfer payments)

Question 29

What is gross investment?

Answer 29

Everything before deductions

Question 30

What is net investment?

Answer 30

Gross investment depreciation - All deductions considered
- Gives more accurate picture of ‘capital stock/capacity’

Question 31

What is depreciation?

Answer 31

Price falling due to ‘wear and tear’

Question 32

What is the accelerator effect?

Answer 32

Consumption increasing requires more production from firms. Eventually firms decide to increase capacity:
- E.g., capital stock
Therefore capital expenditure increases.
Thus, investment increases, capacity increases, employment increases, and therefore consumption increases -> increase in AD
- When firms increase capacity as a result of consumption increasing - this is known as the accelerator effect

Question 33

What are animal spirits?

Answer 33

• Affects both consumption and investment
• Keynes came up with it
• Describes the importance of confidence and ‘gut instincts’ of firms relating to future businesses and macroeconomic prospects
• Can be measured in terms of consumer confidence

Question 34

Animal spirits: What do firms and consumers do when they fear there will be a recession with increased unemployment and falling profits?

Answer 34

• Consumers save so consumption decreases
• Firms decrease investments and save
• Firms increase prices

Question 35

What is the paradox shift?

Answer 35

When saving increases, investment decreases -> demand and incomes in the circular flow decrease -> big decrease in aggregate demand

Question 36

Factors that influence Investment?

Answer 36

1) Rate of economic growth
2) Business expectations and confidence
3) Animal spirits
4) Export Demands
5) Interest Rates
6) Access to credit
7) Government and Regulations

Question 37

How does rate of economic growth influence investment?

Answer 37

Increased growth leads to increased investment and thus increased confidence

Question 38

How do business expectations and confidence influence investment?

Answer 38

Increased confidence and therefore more investment

Question 39

How do animal spirits impact investment?