2.2 Aggregate Demand

Question 1

Define aggregate demand

Answer 1

The total amount spent on goods and services in an economy at any price level

Question 2

AD formula

Answer 2

AD= C + I + G + (X-M)

Question 3

Components of AD

Answer 3

• consumption
• investment
• government spending
• net exports

Question 4

What is consumption?

Answer 4

Consumer expenditure on goods and services in the economy

Question 5

What is investment?

Answer 5

Business expenditure on capital goods/assets (e.g. new and improved technology/machinery, buildings, stock, training of human capital) in order to generate a greater value of output

Question 6

What is government spending?

Answer 6

Government expenditure on providing public sector goods and services (e.g. infrastructure, education, healthcare)

Question 7

What are net exports?

Answer 7

The value of exports minus the value of imports: exports being goods and services sold overseas and imports being goods and services bought into the economy

Question 8

Factors that affect consumption (8)

Answer 8

• MPC/MPS
• interest rates
• consumer confidence
• tastes and attitudes
• taxation
• wealth effects
• unemployment
• (distribution of) income

Question 9

Factors that affect investment (8)

Answer 9

• rates of economic growth
• interest rates
• business confidence (animal spirits)
• demand for exports
• influence of government and regulations
• access to credit
• taxes and subsidies
• technology

Question 10

Factors that affect government spending (3)

Answer 10

• the economic cycle
• fiscal policy (decisions about expenditure and taxation)
• age distribution of the population

Question 11

Factors that affect net exports (5)

Answer 11

• real income/state of the world economy
• exchange rates
• degree of protectionism (tariffs, quotas, subsidies)
• non-price factors (e.g. quality of goods)
• price/inflationary pressure

Question 12

What does the AD curve represent?

Answer 12

The total value of the components of AD in an economy at each price level

Question 13

Describe an AD diagram (3)

Answer 13

• X-axis: real GDP (Y)
• Y-axis: price level (PL)
• the AD curve is downwards sloping (inverse relationship)

Question 14

What causes a movement along the AD curve?

Answer 14

A change in the price level
- increase in the PL = contraction of AD (decrease in Y)
- decrease in the PL = extension of AD (increase in Y)

Question 15

Why does the AD curve slope downwards? (3)

Answer 15

• the wealth effect
• the trade effect
• the interest effect

Question 16

What is the wealth effect?

Answer 16

As the price level falls, the real value of income increases (can buy more with the same amount of income), meaning that people are likely to consume more, therefore increasing AD [vice versa]

Question 17

What is the trade effect?

Answer 17

As the price level falls, demand for exports increases (more competitive) and demand for imports decrease (less competitive), resulting in the value of net exports rising, therefore increasing the value of AD [vice versa]

Question 18

What is the interest effect?

Answer 18

As the price level falls, low interest rates can be kept in the economy, stimulating higher consumption, higher investment spending (lower cost of borrowing) and reducing the value of the exchange rate (boosts net exports), which increases the components C, I and (X-M), therefore increasing AD [vice versa]

Question 19

What does a shift in the AD curve represent?

Answer 19

Outward/rightward shift: increase in AD
Inward/leftward shift: decrease in AD

Question 20

What causes a shift in AD?

Answer 20

A change in any of the components of AD

Question 21

What is disposable income?

Answer 21

Amount of income earned after tax has been deducted

Question 22

What is discretionary income?

Answer 22

Income after tax, mortgage, rent, bank loans and essentials have been paid for

Question 23

Difference between gross and net investment

Answer 23

Gross investment: all investment spending
Net investment: only investment that increases productive capacity