Theme 2: Aggregate Demand

Question 1

Can you describe to me what 3 things does an aggregate demand curve have?

Answer 1

• Downward sloping line on a graph
• Price Level on the Y-axis
• Real GDP on the X-axis

Question 2

When should you draw a Demand curve, and when should you draw an Aggregate Demand curve?

Answer 2

-Draw a demand curve when you’re referring to just one specific good.
- Draw an aggregate demand curve when you’re referring to an entire economy.

Question 3

State the aggregate demand formula

Answer 3

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

Question 4

What does C stand for?

Answer 4

Consumption

Question 5

What does I stand for?

Answer 5

Investment

Question 6

What does G stand for?

Answer 6

Government spending

Question 7

What does (X - M) Stand for?

Answer 7

Net trade (X = exports, M = imports)

Question 8

What is the formula for Net investment?

Answer 8

Net investment = Gross investment - Depreciation

Question 9

How does income affect AD

Answer 9

Lower incomes = AD shifts left
Higher incomes = AD shifts righ

Question 10

What is the multiplier effect?

Answer 10

when an initial increase in an injection leads to a much bigger, overall effect on the economy.

Question 11

What is disposable income?

Answer 11

Income - Taxes

Question 12

What are the 2 multiplier ratio formulas?

Answer 12

[1/(1-MPC)]
[1/MPW]

Question 13

What does the multiplier ratio show?

Answer 13

The increase in GDP following an initial injections

Question 14

What does marginal propensity to consume mean?

Answer 14

How much consumers will spend if given an additional $

Question 15

What is the Marginal Propensity to Withdraw?

Answer 15

the proportion of any additional income that is withdrawn from the circular flow (i.e. saved, spent on imports or taxed).

Question 16

What is the formula for MPW?

Answer 16

MPS + MPT + MPM

Question 17

What is marginal propensity to save?

Answer 17

The proportion of additional income that is saved.

Question 18

What is marginal propensity to import?

Answer 18

The proportion of additional income that is imported.

Question 19

What is marginal propensity to tax?

Answer 19

The proportion of additional income that is taxed.

Question 20

What is the downward multiplier effect?

Answer 20

When an initial increase in withdrawals leads to a larger decrease in aggregate demand

Question 21

What are benefits?

Answer 21

Payments made to unemployed or low income workers shown as an increase in consumption in the AD formula

Question 22

What is meant by an interest rate when you are saving money?

Answer 22

An interest rate tells you how much interest (or extra money) you’ll get from the bank. This is sometimes called a return on your savings.

Question 23

what is meant by an interest rate when you’re borrowing money?

Answer 23

The percentage of your borrowing which you pay to the bank

Question 24

How does the interest rates affect consumers and firms in 3 ways?

Answer 24

1) they affect consumers who are saving
2) they affect consumers who are borrowing
3) they affect firms who borrow to invest

Question 25

How would interest rates affect AD

Answer 25

Higher interest rates = AD decreases Lower interest rates = AD increases

Question 26

What is the wealth effect?

Answer 26

when an change in wealth makes consumers feel more or less confident which changes their spending decisions

Question 27

What does it mean when we have a high/low MPC?

Answer 27

Low MPC = less likely to spend High MPC = more likely to spend

Question 28

What did Ricardo Sousa state about the wealth effect in Europe?

Answer 28

- The wealth effect in Europe is approximately 0%. - This is because less people in Europe own their own homes. - An increase in house prices will make home-owners feel wealthier and spend more. - However, an increase in house prices means that renters are likely to try and save more in order to get on the property ladder and so they are likely to spend less. - These two effects cancel out to give a wealth effect of 0%.

Question 29

How do benefits cause shifts in AD?

Answer 29

More benefits = increase AD Less benefits = decrease AD

Question 30

How do pensions shift AD?

Answer 30

High pensions = increase AD Low pensions = decrease AD

Question 31

What is animal spirits?

Answer 31

Animal Spirits refer to investor confidence, when animal spirits are high investor confidence is high

Question 32

How do you calculate savings ratio?

Answer 32

Savings ratio = total savings/post-tax income

Question 33

What is the savings ratio?

Answer 33

The percentage of disposable income (income after tax) that consumers will save.