Macro 2 - Aggregate Demand

Question 1

Define the term aggregate demand

Answer 1

Aggregate demand is the total planned expenditure on goods and services produced in an economy

Question 2

What is the formula used to calculate aggregate demand?

Answer 2

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

Question 3

What are the different components that make up aggregate demand?

Answer 3

C - Consumer spending / Consumption
I - Investment
G - Government spending
X - Exports
M - Imports

Question 4

What is consumer spending / consumption?

Answer 4

Consumption / Consumer spending is the total amount spent by households on goods and services. It does not include spending by firms

Question 5

What effect will an increase in consumption have on aggregate demand?

Answer 5

An increase in consumption will increase aggregate demand

Question 6

What effect will a decrease in consumption have on aggregate demand?

Answer 6

A decrease in consumption will decrease aggregate demand

Question 7

What does the government spending component of aggregate demand refer to?

Answer 7

The government spending component of aggregate demand is the money spent by the government on public goods and services. Only money that directly contributes to the output of the economy is included

Question 8

Are transfer payments such as benefits and pensions included in the government spending component of aggregate demand?

Answer 8

No

Question 9

When does a budget deficit occur?

Answer 9

If government spending is greater than its revenue, there will be a budget deficit

Question 10

When does a budget surplus occur?

Answer 10

If government spending is less than its revenue, there will be a budget surplus

Question 11

What are exports?

Answer 11

Exports are goods or services that are produced in one country, then sold in another

Question 12

What are imports?

Answer 12

Imports are goods and services that are brought into a country after being produced elsewhere

Question 13

What is the relationship between exports and imports and aggregate demand?

Answer 13

Exports minus imports (X-M) make up the net exports component of aggregate demand

Question 14

On an aggregate demand diagram what goes on the x-axis?

Answer 14

Real GDP

Question 15

On an aggregate demand diagram what goes on the y-axis?

Answer 15

Price level (PL)

Question 16

On an aggregate demand diagram what letter is used to represent Real GDP on the x-axis?

Answer 16

Y

Question 17

On an aggregate demand diagram what letter is used to represent Price level on the y-axis?

Answer 17

P

Question 18

Does the aggregate demand curve slope upwards or downwards?

Answer 18

Downwards

Question 19

Does the aggregate demand curve slope upwards or downwards?

Answer 19

Downwards

Question 20

Why does the aggregate demand curve slope downwards?

Answer 20

The lower the price level the more output is demanded. Lower prices mean consumers can buy more goods/services with their money

Question 21

What effect will a change in the price level have on the aggregate demand curve?

Answer 21

A change in the price level will cause a movement along the AD curve

Question 22

What effect will a rise in the price level have on aggregate demand?

Answer 22

A rise in the price level will lead to a contraction in aggregate demand

Question 23

What effect will a fall in the price level have on aggregate demand?

Answer 23

A fall in the price level will lead to an extension in aggregate demand

Question 24

Why will a rise in the price level cause output to fall?

Answer 24

• Domestic consumption will be reduced as things become more expensive so people can buy fewer goods and services
• The demand for exports will be reduced as domestically produced products become less competitive
• The demand for imports will increase, if prices haven’t risen abroad imports will become cheaper in comparison

Question 25

If there is an increase in aggregate demand which way will the AD curve shift?

Answer 25

The AD curve will shift right

Question 26

If there is a decrease in aggregate demand which way will the AD curve shift?

Answer 26

The AD curve will shift left

Question 27

What causes a shift in the aggregate demand curve?

Answer 27

A change in the size of any of the components that make up aggregate demand

Question 28

What are the factors affecting consumer spending?

Answer 28

- Real disposable income - Wealth - Consumer confidence - Rate of interest - Saving

Question 29

Define the term real disposable income

Answer 29

Real disposable income refers to the flow of money earned after direct taxes and adjusted for inflation

Question 30

What is disposable income?

Answer 30

Disposable income is income minus direct taxes

Question 31

Define the term wealth

Answer 31

Wealth refers to the value of the stock of assets someone owns

Question 32

What is the wealth effect?

Answer 32

The wealth effect refers to the effect on incomes or spending when asset values (wealth) changes. As wealth rises, usually consumer spending also rises

Question 33

Why does consumer spending usually rise when wealth rises?

Answer 33

If wealth increases then individuals have a larger number of personal assets to fall back on. This may provide them with more security and confidence. It would allow them to borrow against this wealth increasing spending.

Question 34

Define the term consumer confidence

Answer 34

Consumer confidence refers to household's optimism or pessimism about their financial circumstances in the future based on their expectations about the economy

Question 35

Explain how an increase in consumer confidence may increase consumer spending

Answer 35

Increased consumer confidence means people may feel more optimistic about their future prospects such as job security and possible pay increases encouraging them to spend more on goods and services

Question 36

Define the term rate of interest

Answer 36

The rate of interest refers to the cost of borrowing or reward for saving with a financial institution such as a bank

Question 37

What effect will lower interest rates have on consumer spending?

Answer 37

- The lower the rate of interest the higher consumer spending will be as there is less incentive to save as there is a smaller return on savings. - It is also cheaper to borrow money so consumers may buy goods and services on credit. - Repayments on existing debt may fall increasing discretionary income

Question 38

What effect will higher interest rates have on consumer spending?

Answer 38

- Higher interest rates lead to less consumer spending as consumers save more as there is a larger return on savings - It is more expensive to borrow money so spending is also likely to decrease

Question 39

What effect will more saving have on consumer spending?

Answer 39

More saving will decrease consumer spending

Question 40

Define the term investment

Answer 40

Investment is money spent by firms on capital goods and assets which will be used to produce more goods or services

Question 41

Define the term gross investment

Answer 41

Gross investment is the total amount spent on investment before any account is taken of depreciation of assets

Question 42

Define the term net investment

Answer 42

Net investment is the amount spent by firms in an economy on capital goods minus depreciation of assets. Net investment only includes investment that increases productive capacity

Question 43

What are the factors which affect investment?

Answer 43

- Rate of economic growth - Amount of spare capacity - Business confidence - Animal spirits - Demand for exports - Rate of interest - Access to credit - Influence of government and regulations

Question 44

What is meant by animal spirits?

Answer 44

The economist Keynes came up with the idea of animal spirits which is the idea that it was not rational thinking that made people buy or sell shares or invest but it was rather an animal or herd instinct similar to herding behaviour

Question 45

What are the three types of government spending?

Answer 45

- Capital expenditure - Current expenditure - Transfer payments

Question 46

What is meant by capital expenditure?

Answer 46

Capital expenditure relates to long-term investment projects in new assets such as hospitals or infrastructure programs

Question 47

What is meant by current expenditure?

Answer 47

Current expenditure is day to day expenditure on goods and services to keep current services working

Question 48

What is meant by transfer payments?

Answer 48

Transfer payments are payments made by the state from tax revenues to individuals in the form of benefits for which there is no production in return