2.2 Aggregate Demand

Question 1

Aggregate demand

Answer 1

Total amount of goods and services demanded in the economy at a given time and price level

Question 2

Reasons for AD sloping downwards

Answer 2

Wealth effect: low price = higher purchasing power = more G+S demanded vice versa

Trade effect: domestic price level increases, X price increase, M price decrease. Therefore, net trade falls. represents fall in quantity of output demanded. vice versa

Interest rate effect: increased price level, consumers need more money, increase in demand for money, increase in interest rate, cost of borrowing increases, decrease in consumer purchases

Question 3

Factors affecting consumption

Answer 3

Real income
Direct taxation
Consumer confidence and expectations
Interest rate - linked with supply of credit (willingness of bank to lend)
Expectations of inflation - durables - EVAL - can be offset by wealth effect where inflation causes negative wealth effect can households save to compensate
Wealth effect - size of relationship between wealth and spending is questionable
Distribution of income - poorer families have a lower savings ratio, so total consumer demand would increase more

Question 4

Investment

Answer 4

Spending on capital goods

Question 5

Replacement investment

Answer 5

purchase of capital goods by firms to replace existing, worn out capital

Question 6

Determinants of investment

Answer 6

Interest rates - low IR, more I financed by borrowing. investment funded by retained profits - low IR, greater incentive to run down savings
Business confidence
Technology improvements
Business tax
Level of corporate indebtedness
Legal changes

Question 7

Advantages of high investment

Answer 7

Injection to circular flow - multiplier effect, some capital goods may be imported: leakage

New capital can aid productivity: additional capacity - may be lengthy time lag between workers getting more capital and productivity rising

Capital investment may replace labour and cause short term unemployment

I supports country’s competitiveness and will improve trade balance - many other factors affect competitiveness including exchange rate

Question 8

accelerator effect

Answer 8

when an increase in national income (GDP) results in a proportionately larger rise in capital investment spending

Question 9

factors affecting gov spending

Answer 9

tax revenue: increased tax revenue = more funds to increase spending
state of economy: higher employment = gov spending decrease on benefits
gov debt: debt servicing, interest repayments
type of economy