2.2- Aggregate demand

Question 1

What is aggregate demand?

Answer 1

the total demand in the economy. measures spending on goods and services by consumers, firms, the government and overseas consumers and firms.

Question 2

What components is AD made up of?

Answer 2

C+I+G+ (X-M)
Consumer spending
Investment
Gov spending
Exports minus imports

Question 3

Why does the AD curve slope downwards?

Answer 3

• higher prices lead to a fall in income, so goods and services become less affordable.
  -High inflation means interest rates would be higher, this discourages spending.

Question 4

What shifts the AD curve?

Answer 4

The 5 components

Question 5

What is consumer spending?

Answer 5

How much consumers spend on goods and services.

Question 6

How much of GDP does consumer spending make up?

Answer 6

60%, largest component of AD

Question 7

What is disposable income?

Answer 7

The amount of income consumers have left over after taxes and social security charges. What consumers choose to spend.

Question 8

What is a consumer’s marginal propensity to consume?

Answer 8

How much a consumer changes their spending following a change in income.

Question 9

What is a consumer’s marginal propensity to save?

Answer 9

The proportion of each additional pound of household income that is used for saving.

Question 10

What does a consumer’s marginal propensity to save added to marginal propensity to consume is?

Answer 10

1

Question 11

How do interest rates influence consumer spending?

Answer 11

Lower interest rates, cheaper to borrow and reduces incentive to save.
-Spending increases.
Low interest rates also lowers cost of debt, such as mortgages, cheaper to pay it back.

Question 12

How does consumer confidence influence consumer spending?

Answer 12

High confidence levels means consumer spend more because they are less concerned for the future.
If consumers fear unemployment they might feel less confident and so spend less.

Question 13

What is the wealth effect and how does it influence consumer spending?

Answer 13

Wealth effect- rise in the price and worth of their house makes people feel wealthier and they are likely to spend more.

Question 14

What is a consumer’s housing equity?

Answer 14

The difference between the market value of a property and how much loan is remaining to be paid. If house prices increase, consumers experience a rise in equity.

Question 15

What is the difference between gross and net investment?

Answer 15

Gross investment- the amount a firm invests in business assets that does not account for depreciation. A depreciation is when something starts to lose value.
Net investment- The actual addition to the capital stock of an economy, after depreciations have been considered.

Question 16

How do you calculate net investment?

Answer 16

Net invest= gross invest - depreciation

Question 17

How does economic growth influence investment?

Answer 17

If growth is high, firms make more revenue due to high consumer spending. More profits to invest.

Question 18

How does business expectations and confidence influence investment?

Answer 18

• If firms expect a high rate of return, they will invest more.
  -Keynes coined the term animal spirits, when describing instincts and emotions of human behaviour which drives level of confidence in an economy.

Question 19

How does demand for exports influence investment?

Answer 19

The higher the demand is, the more likely it is firms will invest because they expect higher sales.

Question 20

How does interest rates influence investment?

Answer 20

Investment increases as interest rates fall.
Cost of borrowing is less and return to lending is higher.
High interest rates might make firms expect a fall in consumer spending, which is likely to discourage investment.

Question 21

How does access to credit influence investment?

Answer 21

If banks are unwilling to lend, after a financial cricis, firms will find it harder to gain access to credit- not possible to gain the funds for investment.

Question 22

How do governments and regulations influence investment?

Answer 22

• The rate of corporation tax.
  -Lower taxes means firms keep more profits, encouraging investment.
  Subsidies encourage investment.
  High regulation discourages investment.

Question 23

What is the trade cycle?

Answer 23

Another term for the business cycle, refers to the stage of economic growth that the economy is in.
The economy goes through periods of booms and busts.

Question 24

What is the recovery stage?

Answer 24

Real ouput increases when there are periods of economic growth.

Question 25

What is a boom?

Answer 25

When economic growth is fast, could be inflationary or unsustainable.

Question 26

What is a recession?

Answer 26

When real output in the economy falls, negative economic growth.

Question 27

What does the government do during a recession?

Answer 27

increase spending to try stimulate the economy, such as on welfare payments. This will increase gov deficit.

Question 28

What does the government do during economic growth period?

Answer 28

Receive more tax revenue since consumers spending more.
Spend less.

Question 29

What is fiscal policy?

Answer 29

Changing government spending and taxation. Government might spend on public goods and merit goods.
It is a demand side policy, influences AD.

Question 30

What is expansionary fiscal policy?

Answer 30

Increasing spending, or on boosting AD and reducing taxes. Used during recession.

Question 31

What is contractionary fiscal policy?

Answer 31

Decreasing spending and increasing tax. Improves gov deficit.

Question 31

What is contractionary fiscal policy?

Answer 31

Decreasing spending and increasing tax. Improves gov deficit.

Question 32

What is net trade (X-M)

Answer 32

Exports minus imports.
This is the value of the current account on the balance of payments.
The UK has a large deficit, which reduces vale of AD.

Question 33

How does real income influence the net trade balance?

Answer 33

during economic growth consumers have higher incomes so they can import more. Large deficit on the current account.
During economic decline, incomes fall, meaning lower imports.
Incomes have little impact on exports.

Question 34

How do exchange rates influence the net trade balance?

Answer 34

• A depreciation in the pound means imports expensive, exports are cheaper.
• People are less likely to buy imports and more likely to buy exports.
• Depreciations creates more competition against other currencies.
• If a dollar or euro depreciates it has more of a significant effect to the UK as it is a trading partner.
  -the demand for UK exports has to be price elastic to lead to an increase in exports.

Question 35

How does the state of the world economy influence the net trade balance?

Answer 35

A decline in economic growth in one of the UK’s export markets (such as the EU) there will be a fall in exports, because consumer spending in those the EU will fall due to lower incomes.

Question 36

How does degree of protectionism influence the net trade balance?

Answer 36

Protectionism is the act of guarding a country’s industries from foreign competition.
Through using tarrifs, quotas, regulation or embargoes.
- If the UK employed several protectionist measures, then the trade deficit will reduce because UK will be importing less.

Question 37

What non price factors influence the net trade balance?

Answer 37

• the competitiveness of a country’s goods and services.
  -A country can become more competitive by having high quality goods, advertising, strong customer service and operating in a niche market, better infrastructure. These increase exports.