Components of AD

Question 1

What is AD?

Answer 1

The total demand/spending in an economy over a given period of time

Question 2

AD formula?

Answer 2

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

Question 3

Consumption makes up how much of the UK AD?

Answer 3

65%

Question 4

When consumption is high what tends to be low?

Answer 4

Savings and vice versa

Question 5

What factors affect Consumption and Saving?

Answer 5

Income - If Disposable income increases, then so will consumption

Interest rates - increased I.r means less consumption - save more to take advantage of this and not borrow as it is more expensive to do so

Consumer Confidence - If confident in economy - spend more and save less - recessions can reduce this

Wealth - a rise in house prices - rises consumer spending and reduction in saving - if house prices are rising faster than inflation

Taxes - direct - disposable income falls - reduction in consumption - same with indirect

Unemployment - rise in this means less consumption and increased saving

Question 6

Savings is different to investment how?

Answer 6

Savings made by households, investments are normally by firms

Question 7

Define investment?

Answer 7

Money spent by firms on assets which they will use to produce g + s

Question 8

Gross Investment is what?

Answer 8

includes all investment spending

Question 9

Net investment is what?

Answer 9

Only includes investment that increases productive capacity

Question 10

What is the reason for investing?

Answer 10

Firms use it with the intention of making profit in the future

Question 11

How much of the UK AD does investment make up?

Answer 11

15%

Question 12

What is a factor affecting investment?

Answer 12

Risk - lvl of risk will affect the amount - high risk that a firm won’t benefit then they won’t invest
eg. economic instability

Question 13

Second factor affecting investment?

Answer 13

Government incentives and regulations
Subsidies or Taxes - affect lvl - reduction in corporation tax will encourage investing

Relaxed regulations - reduces firms costs therefore more likely investing

Question 14

Third factor affecting investment?

Answer 14

Interest rates and credit
Firms often borrow money to invest - high interest rates/ less access to credit means less investment

Greater opportunity cost to invest the existing funds than put them into a bank account

Question 15

Fourth factor affecting investment?

Answer 15

Technical advances - Firms need to invest in new tech to stay competitive

Question 16

Fifth factor affecting investment?

Answer 16

Business confidence and ‘animal spirits’
More confident a business is in its ability to make profit - more likely to invest
Depends on optimism/pessimism of managers - Keynes said not all investment is made rationally
‘animal spirits’ - gut instinct etc

Question 17

What does Government spending not include?

Answer 17

Tranfers of money
eg. benefits like JSA or pensions

Question 18

What is government spending?

Answer 18

Money spent by Gov on public goods and services - only money directly contributing to the output of the economy

Question 19

What is a budget deficit?

Answer 19

If gov spending is greater than its revenue

Question 20

What is a budget surplus?

Answer 20

If gov spending is less than its revenue

Question 21

What do Governments use to alter their spending and taxation?

Answer 21

Fiscal policy

Question 22

What will an imbalance in the budget do to the circular flow?

Answer 22

A surplus - indicates an overall withdrawal
A deficit - indicates an overall injection

Question 23

When is an imbalance okay?

What happens in the long run?

Answer 23

In the short run
Long term surplus - Gov harms economic growth - choosing not to spend or high taxes
Long term deficit - means a country is likely to have a high national debt

Question 24

Is an export an injection or withdrawal?

Answer 24

It is an injection
(meaning imports are a withdrawal)

Question 25

If the amount spent on imports exceeds amount received for exports what does this mean?

Answer 25

Net exports will be a negative number

Question 26

Define exchange rates

Answer 26

The value of a currency

Question 27

How do exchange rates affect net exports in the long run?

Answer 27

If the value of a currency increases imports become relatively cheaper and exports become expensive for foreigners Demand for M increases and demand for X falls So a strong currency will worsen net exports and reduce AD

Question 28

How do exchange rates affect net exports in the short run?

Answer 28

Demand for X and M tend to be price inelastic - initially when the value increases net exports will improve because overall value of exports increases and imports decreases

Question 29

How do changes in the state of the world economy affect net exports?

Answer 29

The higher a country's real income the more they import - net export will fall World economy - eg. USA exports to Canada If Canada experiences high growth rates, exports from USA will increase - improving net exports and vice versa

Question 30

How does the degree of protectionism affect net exports?

Answer 30

Tariffs and Quotas in the short run can increase net exports by reducing imports Industries protected from international competition have few incentives to become more efficient - X less in long run

Question 31

How do non price factors affect net exports?

Answer 31

Quality of goods - advancements in technology which will increase quality of goods likely causes increase in exports - people willing to pay more if its good quality improvement in net exports