10.3 The Determinants Of Aggregate Demand

Question 1

What are the four determinants of AD

Answer 1

Consumption
Investment
Gov spending
Net export demand

Question 2

What is aggregate consumption?

Answer 2

Total spending of all households

Question 3

What is a determinate of consumption?

Answer 3

Household saving

Question 4

What is the rate of interest?

Answer 4

The reward for lending savings to someone (bank) or cost of borrowing

Question 5

What are the determinants of income(8)

Answer 5

Interest rates
Level of income
Expected future income
Wealth
Consumer confidence
The availability of credit
Distribution of income
Expectation or future inflation

Question 6

What is Keynesian theory of consumption and saving

Answer 6

As income rises though absolute consumption rises consumption falls as a fraction of total income

(Cause of recessions too much saving and too little spending)

Question 7

What is the life-cycle theory of consumption?

Answer 7

A theory that explains how consumption and saving in terms of how people expect their income to change over the whole of their life cycles

Question 8

How can wealth a determinant of income or consumption?

Answer 8

Wealth increases saving for them so they don’t have to save, more money available for consumption

Question 9

What is the availability of credit ?

Answer 9

Funds available for households and firms to borrow

Question 10

What is the state of consumer confidence linked to?

Answer 10

People’s views on expected income and changes with personal wealth

Consumer optimism increases-households spend more and save less

Question 11

What is credit crunch

Answer 11

Occurs when there is a lack of funds available in the credit market, making it difficult for borrowers to obtain financing, and leads to a rise in the cost of borrowing

Question 12

What happens to consumption if credit is an available cheaply and easily ?

Answer 12

Consumption increases as people supplement current income by borrowing

Question 13

What is the distribution of income .

Answer 13

The spread of different incomes among individuals and different income groups of the economy

Question 14

How id consumption influenced by the distribution of income ?

Answer 14

Rich people have a greater proportion of income to save than poorer people

Question 15

How does inflation affect consumption

Answer 15

Rising inflation leads to precautionary consumption (decrease) or can have the opposite effect as households decide to spend more immediately

Question 16

What is the equation of savings

Answer 16

Income -costs

Question 17

What is the equation of the personal savings ratio

Answer 17

Realised or actual personal saving/personal disposable income

Question 18

What does the personal savings ratio measure?

Answer 18

The actual or realised saving of the personal sector as a ratio of total personal sector disposable income

Question 19

How are savings and investments different

Answer 19

Saving is income not spend on consumption

Investment is spending on capital goods

Physical and financial investment are different

Question 20

What is financial investment

Answer 20

Financial assets such as shares and bonds

Question 21

Who usually saves and who usually invests

Answer 21

Saves: households
Invests: firms

Question 22

What are the two parts of a country’s gross investment?

Answer 22

Replacement investment (to make good depreciation or capital consumption)-maintains the size of capital stock e.g replacing things

Net investment which adds to capital stock

Question 23

What are the two key aspects for economic growth

Answer 23

Investment
Technical progress

Question 24

What four factors influence the rate of investment?

Answer 24

-interest rate

-relative prices of capital and labour

-the nature of technical progress

-the adequacy of financial institutions in the supply of investment funds

Question 25

How does the relative prices of capital and labour affect investment?

Answer 25

When the price of capital rises firms adopt labour intensive methods

Drop on capital price leads to more investment of capital goods

Question 26

How does the nature of technical progress affect investment?

Answer 26

Technical progress causes investment in new up to date machinery

Question 27

How does the adequacy of financial institutions in the supply of investment funds affect investment?

Answer 27

Many investments in fixed capital goods are long term investments that yield most of their expected incomes years later

-these investments become difficult to finance

banks have been criticised for favouring short term investments over long term investments

Question 28

Why do gov make bad investments

Answer 28

They don’t face the risk of bankruptcy as a result of a poor decision

Question 29

What is the accelerator process?

Answer 29

A change in the level of investment in new capital goods introduced by a change in national income or output. The size of the accelerator depends on the economy’s output-capital ratio

Question 30

Describe the accelerator?

Answer 30

When output accelerated so does investment

Vice versa