Macro 2.2

Question 1

What is aggregate demand (AD)?

Answer 1

The total level of spending in the economy at any given price

AD is calculated as AD = C + I + G + (X - M), where C is consumption, I is investment, G is government spending, and (X - M) is net exports.

Question 2

What are the components of aggregate demand?

Answer 2

• Consumption (C)
• Investment (I)
• Government spending (G)
• Net exports (X - M)

Consumption makes up about 60% of AD, investment about 15-20%, government spending around 18-20% of GDP, and net exports about 5%.

Question 3

What does consumption refer to in the context of aggregate demand?

Answer 3

Consumer spending on goods and services

It is the largest component of aggregate demand.

Question 4

How much of aggregate demand does investment account for?

Answer 4

About 15-20%

Most investment is by the private sector (about 75%).

Question 5

What is government spending in terms of aggregate demand?

Answer 5

Spending by the government on providing goods and services

Includes wages and salaries of public sector workers and investment goods like new roads and schools.

Question 6

What are transfer payments, and are they included in aggregate demand?

Answer 6

Payments such as pensions and jobseekers’ allowances; they are not included in AD

Transfer payments are just transfers of money from one group to another.

Question 7

What does net exports represent in aggregate demand?

Answer 7

Exports minus imports

A negative figure indicates that imports are higher than exports.

Question 8

What is the shape of the aggregate demand curve?

Answer 8

Downward sloping

It shows the relationship between price level and real GDP.

Question 9

What is the income effect?

Answer 9

A rise in prices reduces real incomes, leading to a contraction in demand

People can afford to buy less when their real income decreases.

Question 10

What is the substitution effect?

Answer 10

If prices in the UK rise, demand for British exports decreases while demand for cheaper imports increases

This leads to a decrease in net exports and a contraction in aggregate demand.

Question 11

What is the real balance effect?

Answer 11

A rise in prices reduces the value of savings, leading to decreased spending

People feel less secure and may want to save more.

Question 12

What is the interest rate effect?

Answer 12

Rising prices increase demand for money, leading to higher interest rates

Higher interest rates reduce borrowing and investment, causing a contraction in aggregate demand.

Question 13

What causes movements along the AD curve?

Answer 13

Changes in prices due to inflation or deflation

Movements along the curve indicate changes in the quantity of AD at different price levels.

Question 14

What causes shifts of the AD curve?

Answer 14

Changes in any other variable affecting aggregate demand

A shift to the right indicates an increase in AD, while a shift to the left indicates a decrease.

Question 15

What is disposable income?

Answer 15

The money consumers have left to spend after taxes and state benefits

It is a key factor determining the level of consumption.

Question 16

What is the marginal propensity to consume (MPC)?

Answer 16

The proportion of additional income that is spent on consumption

MPC is usually positive but less than 1 for most people.

Question 17

What is the average propensity to consume (APC)?

Answer 17

The average amount spent on consumption out of total income

In an industrialized country, the APC is likely to be less than one.

Question 18

What is the relationship between savings and consumption?

Answer 18

An increase in consumption decreases savings

Factors affecting consumption also affect savings in the opposite way.

Question 19

What is the marginal propensity to save (MPS)?

Answer 19

The proportion of additional income that is saved

MPS = change in savings/change in income.

Question 20

What factors influence consumer spending?

Answer 20

• Interest rates
• Consumer confidence
• Expectations regarding taxation and interest rates
• Wealth effects
• Distribution of income

High interest rates increase costs and reduce consumption.

Question 21

What is the wealth effect?

Answer 21

A change in consumption following a change in wealth

Greater wealth leads to greater levels of consumption due to increased confidence.

Question 22

What is the relationship between greater wealth and consumer spending?

Answer 22

Greater wealth improves consumer confidence, leading to greater spending.

Question 23

How does the distribution of income affect consumption?

Answer 23

Those on high incomes tend to save a higher percentage of their income, affecting consumption levels.

Question 24

What happens to consumption if money is moved from the rich to the poor?

Answer 24

Consumption is likely to increase as the poor have a higher marginal propensity to consume (MPC).

Question 25

How do tastes and attitudes influence spending behavior?

Answer 25

A strong materialistic drive encourages people to spend, potentially even above their income.

Question 26

Define investment in economic terms.

Answer 26

Investment is the addition of capital stock to the economy, such as machines and factories used to produce goods and services.

Question 27

Differentiate between gross and net investment.

Answer 27

Gross investment ignores depreciation, while net investment is gross investment minus the value of depreciation.

Question 28

Why is the distinction between net and gross investment important?

Answer 28

In the UK, depreciation accounts for about 75% of gross investment.

Question 29

What effect does a growing economy have on investment?

Answer 29

Higher levels of investment occur as businesses are more confident and demand increases.

Question 30

What are 'animal spirits' in the context of investment?

Answer 30

'Animal spirits' describe the confidence of businesses regarding future growth and profitability.

Question 31

How does demand for exports influence investment?

Answer 31

Increased demand for exports leads to higher investment by exporting firms to meet extra demand.

Question 32

What is the impact of high interest rates on investment?

Answer 32

High interest rates increase borrowing costs, making businesses more cautious about investments.

Question 33

What does Keynes’ Marginal Efficiency of Capital (MEC) graph illustrate?

Answer 33

It shows how higher interest rates lead to a fall in investment due to required rates of return.

Question 34

How can government policy influence investment?

Answer 34

Governments can encourage investment through tax breaks or grants.

Question 35

What is the effect of access to credit on investment?

Answer 35

High-risk investments have lower access to credit, leading to decreased investment.

Question 36

What are retained profits?

Answer 36

Retained profits are the profits kept by a firm and not distributed to shareholders.

Question 37

How does technological change impact investment?

Answer 37

Improvements in technology can increase profitability and require businesses to invest to stay competitive.

Question 38

What happens to investment levels when the cost of capital projects rises?

Answer 38

Higher costs increase risk, leading to lower levels of investment.

Question 39

What role does government spending play in aggregate demand (AD)?

Answer 39

Government spending significantly impacts AD through expenditures on various sectors.

Question 40

How does the trade cycle influence government expenditure?

Answer 40

Governments may adjust spending to manage AD and regulate the trade cycle, increasing spending in recessions.

Question 41

What is fiscal policy?

Answer 41

Fiscal policy involves government decisions regarding spending and taxes based on priorities.

Question 42

How does the age distribution of the population affect government spending?

Answer 42

An ageing population leads to increased spending on pensions and social care, while a young population increases education spending.

Question 43

Define net trade.

Answer 43

Net trade is the total exports minus the total imports.

Question 44

What effect does high real income have on net trade?

Answer 44

High real income tends to increase imports, potentially decreasing net trade.

Question 45

How do exchange rates influence net trade balance?

Answer 45

A strong pound makes imports cheap and exports expensive, leading to decreased net trade.

Question 46

What happens to imports when foreigners find it more expensive to buy pounds with their local currency?

Answer 46

Imports will increase and exports will decrease, leading to a decrease in net trade.

Question 47

What is the effect of price elasticity on imports?

Answer 47

If imports are price elastic, a rise in price will cause a large fall in demand; if inelastic, a rise in price leads to a small fall in demand.

Question 48

How does the price elasticity of demand (PED) affect exports?

Answer 48

If exports are inelastic, a rise in price results in a rise in value; if elastic, it causes a fall in value.

Question 49

What is the outcome when both imports and exports are elastic?

Answer 49

A rise in the value of the pound will lead to a fall in net trade.

Question 50

How does the state of the world economy influence UK exports?

Answer 50

If the UK’s main export country is doing well, UK exports are likely to rise, increasing net trade.

Question 51

What factors determine the effect of the world economy on UK trade?

Answer 51

The countries doing well and the trade relationship the UK has with them.

Question 52

Define protectionism.

Answer 52

An attempt to prevent domestic producers from suffering from competition abroad.

Question 53

What are common methods of implementing protectionism?

Answer 53

* Tariffs * Quotas * Technical barriers

Question 54

What happens to UK exports if there is high protectionism from other countries?

Answer 54

UK exports will decrease as it becomes harder for UK firms to sell their goods abroad.

Question 55

What is the effect of high protectionism on imports into the UK?

Answer 55

Imports will decrease.

Question 56

What is the potential consequence of the UK imposing protectionist measures?

Answer 56

Other countries are likely to retaliate, causing a decrease in UK exports.

Question 57

How does free trade affect net trade in relation to aggregate demand (AD)?

Answer 57

Net trade will be a more significant part of AD, either positively or negatively.

Question 58

Name two non-price factors that affect net trade.

Answer 58

* Quality and design * Marketing

Question 59

What is the impact of high quality and design of UK goods on trade?

Answer 59

Exports will be high and imports will decrease, increasing net trade.

Question 60

How does effective marketing influence net trade?

Answer 60

Well-marketed UK goods increase exports and decrease imports, leading to increased net trade.

Question 61

What is the relationship between high prices of UK goods and their competitiveness?

Answer 61

High prices make UK goods less competitive, leading to a decrease in exports and an increase in imports.

Question 62

How does the inflation rate affect prices of UK goods?

Answer 62

If the UK inflation rate is higher than other countries, prices will rise faster.

Question 63

What role does productivity play in determining prices?

Answer 63

Higher productivity leads to lower costs, resulting in lower prices.

Question 64

How does price elasticity of demand (PED) influence net trade in response to changing prices?

Answer 64

If PED is elastic, higher prices will lead to a fall in net trade.