2.2 AGGREGATE DEMAND

Question 1

i. What is Aggregate Demand?

Answer 1

-the total demand for goods and services within an economy at any given time.

Question 2

ii. What are 4 components of AD?

Answer 2

-Consumption, government spending, net exports, investment

Question 3

iii. What % of AD is comprised of each component?

Answer 3

household consumption (C) makes up approximately 65% of AD, government spending (G) accounts for approximately 25% of AD, investment (I) is around 15% of AD, and net exports (X-M) around -5% of AD

Question 4

iv. Explain why a 1% increase in consumption would have a bigger impact on the economy than a 1% increase in investment

Answer 4

consumption takes up 65% of the total of Aggregate Demand whereas investment holds 25%

Question 5

v. Explain 3 reasons why the AD curve is downward sloping

Answer 5

-The aggregate demand (AD) curve slopes downward becauseoutput decreases as the price level increases

Question 6

i. Define Consumption

Answer 6

-The use of goods and services by households

Question 7

ii. Define Disposable Income

Answer 7

-the amount of money that an individual or household has to spend or save after income taxes have been deducted

Question 8

iii. Explain the relationship between Disposable Income and Consumption

Answer 8

-If disposable income decreases, households have less money to spend and save, which then forces consumers to consume less and become more frugal

Question 9

v. Explain the relationship between Savings and Consumption

Answer 9

-If income goes up then consumption will go up and savings will go up

Question 10

v. How is the (Household) Savings Ratio calculated?

Answer 10

-household saving divided by household disposable income

Question 11

vi. What is the current Household Savings Ratio?

Answer 11

-16.9%

Question 12

vii. Give 3 reasons why interest rates and consumption are inversely related

Answer 12

-When interest rates rise, bond prices fall, and vice versa

Question 13

viii. Explain the relationship between confidence and consumption

Answer 13

-consumer confidence,an economic indicator that measures the degree of optimism that consumers have regarding the overall state of a country’s economy and their own financial situations. The increase in consumer spending in turn helps the economy sustain its expansion

Question 14

ix. Define Wealth

Answer 14

-Wealthmeasures the value of all the assets of worth owned by a person, community, company, or country

Question 15

x. Explain how changes in wealth may change consumption

Answer 15

-The positive impact on consumption due to theincrease in housing wealth
is called housing wealth effect

Question 16

i. Define Investment

Answer 16

-the production of goods that will be used to produce other goods

Question 17

ii. Explain the difference between net and gross investment

Answer 17

-Net investment isthe total amount of money that a company spends on capital assets, minus the cost of the depreciation of those assets. Gross Investment is defined as the total expenditure or investment that is made by a company to acquire capital goods

Question 18

iv. Explain the two ways in which investment may be funded

Answer 18

-Debt finance – money provided by an external lender, such as a bank, building society or credit union.
Equity finance – money sourced from within your business

Question 19

v. Define Interest Rates

Answer 19

-the proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding.

Question 20

vi. Explain the relationship between interest rates and level of investment

Answer 20

-If interest rates are increased then it will tend to discourage investment because investment has a higher opportunity cost

Question 21

vii. Explain the relationship between economic growth and level of investment

Answer 21

-the level of investment is dependent on the rate of change of economic growth

Question 22

viii. Explain the relationship between business expectations/confidence and level of investment

Answer 22

-Uncertainty about the future can reduce confidence, and means thatfirms may postpone their investment decisions until confidence returns

Question 23

ix. Explain what is meant by ‘animal spirits’

Answer 23

-the tendency for investment prices to rise and fall based on human emotion rather than intrinsic value

Question 24

x. Explain the relationship between demand for exports and level of investment

Answer 24

-Growing export sales provide revenues and profits for businesses which can then feed through to anincrease in capital investment spending
through the accelerator effect

Question 25

xi. Explain the relationship between the access to credit and the level of investment

Answer 25

-Creditconstraints are significant forinvestment
decisions

Question 26

i. Explain what is meant by Government Expenditure

Answer 26

-spending by the government to affect long run or short run growth

Question 27

types of government spending

Answer 27

-current spending (maintenance of services or payment of labour wages) (injection)

-capital spending (new infrastructure projects) (injection)

-welfare spending (benefits and pensions) (injection)

-debt interest payments

Question 28

budget deficit

Answer 28

when government spending is greater than taxation revenues in a fiscal year

Question 29

budget surplus

Answer 29

-when government spending is less than taxation in a fiscal year

Question 30

v. Explain the difference between expansionary and contractionary fiscal policy

Answer 30

-Contractionary fiscal policy is when the government taxes more than it spends.
Expansionary fiscal policy is when the government spends more than it taxes

Question 31

i. Explain the meaning of Trade Balance

Answer 31

the difference in value between a country’s imports and exports

Question 32

ii. Explain the difference between Exports and Net Exports

Answer 32

-A nation’s net exports are the value of its total exports minus the value of its total imports