Aggregate Demand

Question 1

Define Aggregate Demand?

Answer 1

The total demand for goods and services in an economy at a given price level in a given time period.

Question 2

What four components is Aggregate Demand divided into?

Answer 2

• Consumption
• Investment
• Government spending
• Foreign Purchases

Question 3

What comes under consumption?

Answer 3

Household spending

Question 4

What comes under investment?

Answer 4

Spending by firms

Question 5

What isn’t included in government spending in AD?

Answer 5

It does not include transfer payments like benefits.

Question 6

What comes under and what doesn’t come under foreign purchases in AD?

Answer 6

• Foreign purchases includes exports

- Foreign purchases does not include imports because imports are not made by the economy.

Question 7

What is the formula for AD?

Answer 7

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

AD= consumption+investment+government spending+(exports-imports

Question 8

What goes on the X axis on the AD curve?

Answer 8

Real GDP

Question 9

What goes on the Y axis on the AD curve?

Answer 9

Price Level

Question 10

If the price level is high…

Answer 10

The national output is low

Question 11

If the price level is low…

Answer 11

The national output is high

Question 12

What’s the largest component of AD?

Answer 12

Consumption

Question 13

What are the 8 determinants of consumption?

Answer 13

1) Income
2) Wealth
3) Rate of Interest
4) Tax
5) Availability of credit
6) Expectations
7) Age Distribution
8) Inflation

Question 14

What impact should an increase in Income have on consumption?

Answer 14

An increase in income should lead to more consumption.

Question 15

What is Marginal Propensity to Consume (MPC)?

Answer 15

The percentage of extra income spent.

Question 16

What is the formula for MPC?

Answer 16

MPC= change in consumption/change in income

Question 17

What is the difference between wealth and income?

Answer 17

Wealth is a stock, income is a flow.

Question 18

What makes up wealth?

Answer 18

money+assets (that have a realistic monetary value)

Question 19

What is the wealth effect?

Answer 19

Where a rising asset value leads to increased confidence to spend, even though they don’t have any more money.

Question 20

What form of inflation to governments generally think is good to do with the wealth effect, and why?

Answer 20

Governments believe that rising house prices are the only good form of inflation because it encourages consumption.

Question 21

What effect does the interest rate to do with savings have on consumption?

Answer 21

The interest rate changes the opportunity cost of inflation. If there is a high interest rate then saving may seem like a better option than consuming.

Question 22

What is the opportunity cost of consumption?

Answer 22

Saving

Question 23

What effect does the interest rate to do with borrowing have on consumption?

Answer 23

• The interest rate affects the decision and the ability to borrow. A low interest rate may persuade more people to borrow, which would boost consumption.
• Also if a person has a variable rate mortgagee then that changes a persons disposable income, however fixed rate mortgages will not.

Question 24

What is an example of a direct tax?

Answer 24

Income tax

Question 25

What is an example of an indirect tax?

Answer 25

VAT

Question 26

What's the relationship between change in tax and consumption?

Answer 26

-Decrease tax, increase consumption.

Question 27

What effect does availability of credit have on consumption?

Answer 27

If credit is more available then people are more likely to borrow and therefore spend.

Question 28

What effect do economic expectations have on consumption?

Answer 28

-People speculate into the future conditions of an economy. If the condition of the economy looks good then they will be more likely to spend.

Question 29

What effect does age distribution have on consumption?

Answer 29

Different age groups have different spending patterns.

Question 30

What negative effect does inflation have on consumption?

Answer 30

If prices increase then people will spend less.

Question 31

What positive effect could inflation have on consumption?

Answer 31

Potentially people speculate about further increases in price in the future so they spend more now.

Question 32

Define investment?

Answer 32

Spending by firms on capital goods

Question 33

What are the three determinants of investment?

Answer 33

- Expected future demand - Price of capital goods - Advances in technology

Question 34

What is the impact of the interest rate on investment?

Answer 34

- Much of investment spending is financed by borrowing.Therefore the cost of borrowing is an important factor in an investment decision. - A high rate of interest may make an investment project unattractive in terms of its cost. - A firm hopes to make a profit from an investment, but if the interest rate is high then the overall cost of the investment may be too high for it to make a profit. - Even if a firm finances investment from its own funds, the interest rate is still relevant. A high rate may make saving the money more attractive.

Question 35

Why may a government want to encourage investment?

Answer 35

- It keeps the economy active (more AD) | - It helps to sell exports.

Question 36

What can a government do to encourage investment?

Answer 36

- Lower the rate of corporation tax | - Provide investment subsidies.

Question 37

What effect would lowering the rate of corporation tax have on investment?

Answer 37

Lowering the rate of corporation tax would lower the cost of investment to a firm, thus increasing investment.

Question 38

What effect would providing investment subsidies have on investment?

Answer 38

Investment subsidies would encourage investment by firms because it would lower the cost of investment for a firm.

Question 39

What is the impact of business expectations on investment?

Answer 39

Firms may undertake investment to expand capacity if encouraged by optimistic forecasts of future growth and demand for their products. The amount of expected profit will be a key determinant.

Question 40

What is the impact of changes in technology on investment?

Answer 40

New products create new sales opportunities, thus increase in investment.

Question 41

What are the two categories of government spending?

Answer 41

- Capital spending | - Current spending.

Question 42

What are some examples of government capital spending?

Answer 42

- HS2 - Armed forces weapons - hospital equipment

Question 43

What are some examples of government current spending?

Answer 43

- upkeep of parks - -running a state broadcaster - -electricity bills for government buildings.

Question 44

Determinants of government spending?

Answer 44

- Position in the electoral system - Position in the economic cycle - Ideology - Government income/cost of borrowing

Question 45

What impact does the business cycle have on government spending?

Answer 45

It has an important impact on the level of government income transfers. Movement into recession will increase social security payouts

Question 46

What are the determinants of export spending?

Answer 46

- The business cycles | - Trade competitiveness.

Question 47

What factors determine trade competitiveness?

Answer 47

- Comparative productivity - The determinants of higher productivity - Exchange rates