Y12 Booklet 2: Aggregate Demand

Question 1

What is Aggregate Demand?

Answer 1

the total planned spending on goods/services produced in an economy

i.e. total expenditure

Question 2

What 4 components make up Aggregate Demand?

Answer 2

Consumption
Investment
Government Spending
Net Exports

Question 3

What is the formula for Aggregate Demand?

Answer 3

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

Question 4

What is consumption?

Answer 4

household expenditure on goods/services

Question 5

What is investment?

Answer 5

firm expenditure on capital

Question 6

What is government spending?

Answer 6

government expenditure in the economy

Question 7

What is net exports?

Answer 7

exports - imports
(X-M)

Question 8

When AD increases, what else will increase?

Answer 8

Expenditure, Output and Incomes
(E,O,Y)

Question 9

What 3 areas are consumer spending divided into?

Answer 9

Durables
Non-durables
Services

Question 10

Positives and negatives of increasing consumption

Answer 10

Positives:
- increased employment (more prod = derived demand for labour)
- increased output

Negatives
- demand-pull inflation (excess demand = shortages = price rise)

Question 11

What can influence consumer spending?

Answer 11

1) real incomes and wealth
2) consumer confidence
3) availability of credit
4) interest rates
5) taxation

Question 12

What influences consumer confidence?

Answer 12

• unemployment rates
• job security
• rate of economic growth

Question 13

What is disposable income?

Answer 13

Income - costs
(Y - C)

Question 14

What happens to consumption, when incomes increase?

Answer 14

increase

Question 15

Who sets interest rates in the UK? What do they set?

Answer 15

Bank of England via the Monetary Policy Committee
base rate (bank rate)

Question 16

What is the base rate of interest?

Answer 16

the cost of borrowing for high-street banks

Question 17

What interest payments will affect households?

Answer 17

• savings
• mortgages
• commercial loans
• credit card expenditure

Question 18

How does an increase in interest rates affect spending, with regard to savings?

Answer 18

increased reward for saving, so more incentive to save, less spending

Question 19

How does a decrease in interest rates affect spending, with regard to credit cards?

Answer 19

decreased cost of spending, so less incentive to save, more spending

Question 20

What is APC/APS? What is the formula for this?

Answer 20

Average Propensity to Consume/Save

total consumption expenditure /
total disposable income

Question 21

What is MPC/MPS? What is the formula for this?

Answer 21

Marginal Propensity to Consume/Save

change in consumption expenditure /
change in disposable income

Question 22

APC + APS = ?
MPC + MPS = ?

Answer 22

1

Question 23

What do APC/MPC mean?

Answer 23

the proportion of income which will be spent (consumed)

Question 24

What do APS/MPS mean?

Answer 24

the proportion of income which will be saved

Question 25

What is the multiplier effect?

Answer 25

# | when an initial increase in AD causes an even larger total increase in AD, because households spend more on consumer goods/services e.g. government invests £10m into economy # paid in wages to households # / \ # save £4m (0.4) spend £6m (0.6) # | # paid in wages to households # / \ # save £2.4m (0.4) spend £3.6m (0.6) # | # paid in wages to households # / \ # save £1.44m (0.4) spend £2.16m (0.6) £6m + £3.6m + £2.16m > £10m total increase in NI > initial increase in NI

Question 26

What is the formula for size of multiplier?

Answer 26

1 / MPS

Question 27

What is the explanation of the multiplier effect?

Answer 27

1) initial increase in AD - e.g. govt. intervention 2) real NI increases 3) consumer expenditure increases (increase in Y = increase in C) 4) secondary increase in AD

Question 28

What are the 2 types of investment?

Answer 28

Replacement Investment - replaces capital which has depreciated or been consumed (e.g. fixing machinery) Net Investment - adds/decreases a country's actual stock (gross investment - replacement) [e.g. buying more machinery]

Question 29

What can influence investment spending?

Answer 29

1) price of capital/labour 2) technological advances 3) business confidence (i.e. "animal spirits") 4) business cycle (boom or crash?) 5) interest rates 6) taxation

Question 30

What is the accelerator effect?

Answer 30

when an initial increase in AD causes an even larger total increase in AD, because firms invest more in capital

Question 31

What is the explanation of the accelerator effect?

Answer 31

1) initial increase in AD - so households have more money 2) firms at 100% technical efficiency need more capital to increase production to meet increased demand 3) firms invest in capital 4) secondary increase in AD

Question 32

Positives and negatives of government spending

Answer 32

Positives + economic growth + improves equality + improves labour productivity (e.g. education) Negatives - higher taxation - inefficient/over spending - crowding-out investors + firms

Question 33

When net exports decreases, what happens to AD?

Answer 33

decrease

Question 34

What are some problems with exporting?

Answer 34

- different taxation laws - uncertainty of market - risk of too much pressure on supply chain

Question 35

What is needed for short-run economic growth? (i.e. a positive movement within a PPF)

Answer 35

increased real expenditure: - increased AD - increased short-run AS

Question 36

What is needed for long-run economic growth? (i.e. a positive movement of a PPF)

Answer 36

increased productive capacity: - increased long-run AS

Question 37

On a diagram of GDP, what is a peak called?

Answer 37

"boom"

Question 38

On a diagram of GDP, what is a trough called?

Answer 38

"slump"

Question 39

On a diagram of GDP, what is an increase called?

Answer 39

recovery/growth

Question 40

On a diagram of GDP, what is a decrease called?

Answer 40

recession

Question 41

What defines a recession?

Answer 41

2 consecutive quarters of falling GDP

Question 42

What characterises a "boom"?

Answer 42

- high expenditure (E) - high income (Y) - high output (O) - high consumer confidence - demand-pull inflation

Question 43

What characterises a "slump"?

Answer 43

- low expenditure (E) - low income (Y) - low output (O) - low consumer confidence

Question 44

How can a recession be solved?

Answer 44

increase AD

Question 45

How can AD be increased during a "slump"?

Answer 45

Monetary Policy - decrease interest Fiscal Policy - decrease tax . - increase govt. spending

Question 46

How does GDP generally move over time?

Answer 46

increases, with peaks and troughs

Question 47

What is the AD curve?

Answer 47

Question 48

What causes a shift in the AD curve?

Answer 48

change in C+I+G+(X-M)