2.2 - Aggregate Demand

Question 1

What is aggregate demand?

Answer 1

the total level of spending on goods and services in the economy

Question 2

Why does AD slope downward?

Answer 2

• real balance effect
• international competitiveness
• interest rates
• income effect
• substitution effect

Question 3

What is the formula for AD?

Answer 3

AD = C + I + G + (X-M)
C = consumption (70%)
I = investment (15%)
G = government spending (16%)
(X-M) = net trade (-1%)

Question 4

Consumption

Answer 4

• increase r/i - consumers save > spend
• consumer confidence/ ‘Animal Spirits’ increase -> increase C
• spending on durables and non-durables
• disposable income - determines level of consumption
• wealth effect - increase price of assets, confidence -> increase C

Question 5

What are gross and net investment?

Answer 5

Gross investment - total Investment over a period of time
Net investment - gross investment - depreciation of assets

Question 6

Investment

Answer 6

• increased growth -> increased investment -> accelerator theory (increased Y = increased I)
• ‘Animal Spirits’ increase -> investment increases - businesses are confident
• increased Demand for X -> increased investment (export-led growth)
• increased r/I -> decreased Investment (cost of borrowing rises)

Question 7

What is the MEC?

Answer 7

Marginal Efficiency of Capital = return on investment project

Question 8

Government spending

Answer 8

Government spending is EXOGENOUS
- a part of fiscal policy, on spending taxation
- contractionary = tax > spend
- expansionary = spend > tax
- GS depends on the trade cycle (boom-bust cycle)
- decreased state of economy (recession) -> increased u/e
- increased u/e -> increased G on benefits -> tax revenues
- the opposite happens during an economic boom
- increased G -> increased I -> increased C -> increased AD
- age distribution of population -> older -> increased pensions, wealth, social care -> increased G -> increased AD

Question 9

Net Trade

Answer 9

injection/leakages in circular flow
increased M, decreased X -> decreased (X-M)
decreased M, increased X -> increased (X-M)

Question 10

SPICED and WPIDEC

Answer 10

Strong Pound Imports Cheaper Exports Dearer
Weak Pound Imports Dearer Exports Cheaper

Question 11

Net Trade effects

Answer 11

• real income -> increased Y -> increased M (luxuries) -> decreased (X-M)
• increased £ -> SP IC ED -> increased M, decreased X -> decreased (X-M) -> decreased AD
• state of world economy, increased Y (elsewhere) -> increased X -> increased (X-M) -> increased AD
  -protectionism - “protect” domestic firms from foreign decreased M -> increased AD, other countries retaliate -> decreased X
• non-price factors - reputation
• prices (inflation/productivity)