Aggregate Demand

Question 1

what is aggregate demand?

Answer 1

Aggregate demand (AD) is the total level of spending in the economy at any given price

Question 2

what is aggregate demand made up of?

Answer 2

consumption (C), investment (I), government spending (G) and net exports (X-M).

Question 3

what does the AD curve show?

Answer 3

the relationship between price level and real GDP.

Question 4

why is the AD curve downward sloping?

Answer 4

a rise in prices causes a fall in real GDP and there are four key reasons for this:

The income effect
Substitution effect
Real balance effect
Interest rate effects

Question 5

what causes a movement along the AD curve?

Answer 5

a change in prices , caused by inflation or deflation.

Question 6

what causes a shift of the AD curve?

Answer 6

A shift of the AD curve is caused by a change in any other variable

Question 7

what do shifts to the left and right mean for AD curves?

Answer 7

a shift to the right represents an increase in AD and a shift to the left represents a fall in AD.

Question 8

what is consumption?

Answer 8

Consumption is spending on consumer goods and services over a period of time.

Question 9

what is disposable income?

Answer 9

Disposable income (Y) is the money consumers have left to spend , after taxes have been taken away and any state benefits have been added. This means that disposable income is affected by government taxation as well as wages.

Question 10

what is the most important factor in determining consumption?

Answer 10

disposable income.

Those who are earning a large income will be able to spend much more than those on a minimum wage.

Question 11

What is the average propensity to consume? (APC)

Answer 11

(APC) is the average amount spent on consumption out of total income. In an industrialised country, the APC for the economy is likely to be less than one as people save some of their earnings.

Question 12

how to work out MPC?

Answer 12

MPC= change in consumption

change in income

Question 13

how to work out APC?

Answer 13

APC= total consumption

total income

Question 14

what is the relationship between savings and consumption?

Answer 14

An increase in consumption decreases savings so the same factors which affect consumption are those which affect savings- but in the opposite way. For example, a rise in confidence will decrease
savings

Question 15

what are some influences on consumer spending?

Answer 15

interest rates
consumer confidence 
wealth effects
distribution of income 
tastes and attitudes

Question 16

how do interest rates affect consumer spending?

Answer 16

Most major expenditures are bought on credit so therefore the interest rate will affect the cost of the good for consumers.

Question 17

how does consumer confidence affect consumer spending?

Answer 17

One major factor that affects people’s spending is what they think will happen in the future. If people are confident about the future and expect pay rises, then they will continue or increase their spending.

Question 18

what is the wealth effect?

Answer 18

The wealth effect examines how a change in personal wealth influences consumer spending and economic growth. Rising wealth has a positive impact on consumer spending.
The wealth effect is experienced when
real house prices rise as owners now have more wealth so are more confident with spending as they know that if they go into financial difficulty they could simply borrow more against the house, since their house is worth more than their current mortgage.

Question 19

how does the wealth effect affect consumer spending?

Answer 19

Greater wealth will improve a consumer’s confidence and thus lead to greater spending.

Question 20

how does distribution of income affect consumer spending?

Answer 20

Those on high incomes tend to save a higher percentage of their income than those on low incomes and so a change in the distribution of
money in the economy will affect the level of consumption. If money is moved from the rich to the poor, consumption is likely to increase as the poor have a higher MPC.

Question 21

how do changes to taste and attitudes affect consumer spending?

Answer 21

there is a strong materialistic drive that encourages people to have the newest and the best and therefore spending can be very high, in some cases even above income. If people were less materialistic,
consumption would decrease.

Question 22

what is investment?

Answer 22

Investment is the addition of capital stock to the economy i.e. machines and factories used to produce other goods and services. It is only seen as investment if real products are created so buying a share in a company would be saving but buying new machinery is investment.

Question 23

what is the difference between gross investment and net investment?

Answer 23

Machinery depreciates (loses its value) over time as it wears out or gets used up. Gross investment is the amount of investment carried out and ignores the level of depreciation, whilst net investment is gross investment minus the value of depreciation.

Question 24

what are the influences on investment?

Answer 24

rate of economic growth
business expectation, confidence
demand for exports 
interest rates
government and regulations
access to credit 
retained profit
technological change
costs

Question 25

how does rate of economic growth influence investment?

Answer 25

: In a growing economy, there will be higher levels of investment as businesses would be more confident about their investments and the higher demand would lead to a higher return rate on the investment.

Question 26

what is the accelerator theory?

Answer 26

The accelerator effect states that investment levels are related the rate of change of GDP. Thus an increase in the rate of economic growth will cause a correspondingly larger increase in the level of investment.

Question 27

how does business confidence affect investment?

Answer 27

When businesses are confident about the future and expect future growth, investment will increase as they want to prepare for the future. If they are fearful of the future, then they will not invest money in new ideas or machinery

Question 28

how does demand for exports affect investment?

Answer 28

If the world economy is booming, demand for exports is likely to increase and therefore exporting firms’ investment is likely to increase to cope with this extra demand. This will have a knock-on effect and encourage other firms to increase their investment.

Question 29

how do interest rates affect investment?

Answer 29

Most investment is done through borrowing. High interest rates mean that borrowing is more expensive, so a business needs to be more confident of good profits in order to cover the extra costs of borrowing. Other investment is done through retained profits or savings. A rise in interest rates increases the opportunity cost of a business using retained profits as they are able to get higher interest payments than before.

Question 30

how does government and regulations affect investment?

Answer 30

Governments can encourage investment by their own policy decisions. Regulations also affects investment as a highly regulated economy tends to see less investment as regulation increases the cost and time taken to invest, such as planning regulations

Question 31

how does technological change affect investment?

Answer 31

Improvements in technology will improve or speed up production which will increase the level of profitability, meaning the investment has a better prospect of success. Change also means businesses need to invest to keep up with the best technology

Question 32

how do costs affect investment?

Answer 32

A rise in the cost of any capital project increases the level of risk that you are taking and therefore leads to lower levels of investment. rises in the costs of making goods, such as the raw materials and wage, will decrease investment as it will reduce profitability. This means firms have less money to invest and decreases the rate of return on their investment.

Question 33

what is net trade?

Answer 33

total value of exported goods and services minus total value of imported products.

Question 34

how does real income affect net trade?

Answer 34

if real income is high, there will be increased imports as people demand more= net trade decreases. However, if an increase in real income is due to export-led growth then net trade will increase. Therefore, the effect of changes in real incomes is dependent on many factors

Question 35

how do exchange rates affect net trade?

Answer 35

a strong pound makes imports cheap and exports dear as it costs foreigners more to buy pounds with their currency= imports will increase and net trade decrease however, this depends on elasticity-If imports are price elastic, a rise in price will cause a large fall in demand so the value of imports will fall.

Question 36

how does the state of the worlds economy affect net trade?

Answer 36

If the UK’s main export country is doing well, then UK exports are likely to rise and so net trade is likely to rise. The effect of the state of the world economy is dependent on which countries are doing well and the trade relationship the UK has with them.

Question 37

how does the degree of protectionism affect net trade?

Answer 37

Protectionism is an attempt to prevent domestic producers suffering from competition abroad, through tariffs, quotas and technical barriers. high protectionism on UK exports in other countries= exports decrease as harder for UK firms to sell. high protectionism on imports to UK =imports decrease. if UK imposes protectionist measures, other countries are likely to retaliate and therefore exports are likely to decrease

Question 38

what are non-price factors that affect net trade?

Answer 38

quality and design and marketing. If UK goods are of a higher quality and design, exports will be high as foreign demand for UK goods will increase and imports will decrease as people will buy the British goods instead of foreign goods. This means net trade will increase. If UK goods are well marketed, people will have a stronger desire to buy British goods so exports will increase and imports will decrease, so net trade will increase. Strong quality/design and marketing will mean that British exports are likely to be more inelastic.

Question 39

how can prices affect net trade?

Answer 39

High prices of UK goods will mean that the goods are less competitive compared to international goods since people make decisions partly based on price. This means the volume of exports will decrease and the volume of imports will increase.

Question 40

how does the trade cycle influence gov expenditure?

Answer 40

Decisions over government expenditure may be made in order to manage AD, and therefore regulate the trade cycle. In a recession, the government may increase spending in order to increase demand to reduce unemployment. Government spending also automatically rises during a recession as they have to spend more on unemployment benefits. During booms, the government may decrease spending to decrease demand and reduce inflation.

Question 41

how does fiscal policy influence gov expenditure?

Answer 41

Some government spending is fixed from year to year, for example schools must be funded and pensions must be paid. However, governments can vary what they spend each year, and this is set out in their budget. Fiscal policy is the decisions about government spending and taxes and it will depend on the priorities of the government. The level of government spending depends on what they lay out in their fiscal policy.

Question 42

how does age distribution of the population influence gov spending?

Answer 42

An ageing population leads to increased government expenditure on pensions, social care etc. whilst a young population leads to increased spending on education. The more dependents in the economy (the young and old), the higher government spending tends to be.