2. How the Macroeconomy Works - Aggregate Demand

Question 1

What is aggregate demand?

Answer 1

Aggregate demand is the total demand for countries goods and services at a given price level in a given time period.AD = C+I+G+(X-M)

Question 2

Describe the AD diagram.

Answer 2

Downward sloping AD curvePrice level on the y-axisReal GDP on the X axes

Question 3

Why is AD curve downward sloping?

Answer 3

The wealth effect - CTrade effect - X-MInterest effect - C+I+G+(X-M)

Question 4

How does the wealth effect influence aggregate demand?

Answer 4

As people become richer the purchasing power of the money becomes greater meaning consumption will increase and AD will increase. This is an extension in aggregate demand which occurs as a result in the decrease of the price level. Can occur vice versa.

Question 5

How does the trade affect influence aggregate demand?

Answer 5

If there is a change in price and UK exports become more competitive as well as UK imports becoming less competitive AD will increase as (X - M) becomes more positive. This is an extension of AD - can occur vice versa.

Question 6

How does the interest effect influence aggregate demand?

Answer 6

When price levels and inflation all over the country’s government can set lower interest rate. Low interest rates will encourage greater consumption, investment government spending all of which will boost aggregate demand. This is an extension of AD.

Question 7

Why are WE, TE & IE only extensions or contractions of AD, not movements of the curve?

Answer 7

Because they’re caused only by changes in the price level this means they will either cause contractions or extensions in demand but they won’t shift the curve.

Question 8

Which way along the aggregate demand will the contraction of aggregate demand go?

Answer 8

Left up the curve.

Question 9

Which way along the aggregate demand will the extension of aggregate demand go?

Answer 9

Right down the curve.

Question 10

When will the aggregate demand curve shift?

Answer 10

When there is a change in one of the components in the formula for aggregate demand which is not related to price.Rise to the right.Lower to the left.

Question 11

What is consumption?

Answer 11

Consumption is the total spending on goods and services by households in an economy.

Question 12

What factors will change consumption and shift aggregate demand?

Answer 12

Level of real disposable income - Income Tax?Interest rates/availability of credit Consumer confidence - job opportunities, unemployment?Asset prices - the wealth effectHousehold indebtedness - if in debts more likely to save etc.

Question 13

What is the marginal propensity to consume?

Answer 13

The willingness of the household to spend any extra money they earn. Typically very high in the UK and the majority of this money is spent on imports.

Question 14

What is saving?

Answer 14

The part of a persons disposable income that is not spent on goods or services in the economy.

Question 15

How does saving affect AD?

Answer 15

If you’re not consuming for spending your savings. So the level of savings demonstrates the amount of consumption going on therefore influencing aggregate demand

Question 16

What factors affect the level of savings occurring?

Answer 16

The level of real disposable income Interest ratesConsumer confidenceRange/trustworthiness of financial institutionsTax incentives for example ISA’sAge structure of the population - young + elderly spend more, middle save more

Question 17

What is Investment?

Answer 17

When’s firm spend money on capital goods to increase their productive capacity.

Question 18

What factors can influence the levels of investment?

Answer 18

Interest ratesBusiness confidence – expected profitsCorporation tax – retained profitSpare capacityLevel of competitionPrice of capital goods

Question 19

What is the accelerator effect?

Answer 19

This is when there is an increasing rate of GDP in the economy which encourages greater rate of investment the cycle continues.

Question 20

What are the different types of government spending?

Answer 20

Current spending Capital spendingWelfare spendingDebt interest payments

Question 21

What is current spending?

Answer 21

Spending on the maintenance of public sector services like the NHS and the paying of wages within the public sector.

Question 22

What is capital spending?

Answer 22

Spending on infrastructure projects like building new hospitals and schools.

Question 23

What is welfare spending?

Answer 23

Spending on benefits and pensions.

Question 24

What are debt interest payments?

Answer 24

Interest payments made to other countries from previous debts.

Question 25

Which one of the four types of government spending would not shift aggregate demand to the right?

Answer 25

Debt interest payments as these are payments of money that leave the economy they are leakages and do you not go in to the circular flow of income so don’t boost aggregate demand.

Question 26

What is national debt?

Answer 26

The total stock of debt over time, the accumulation of budget deficit.

Question 27

What factors affect the net exports?

Answer 27

Real disposable income earned abroadReal disposable income and at homeStrong/week exchange rates Protectionism at home and abroadRelative inflation levels at home