2.2 - Aggregate demand

Question 1

What is the definition of aggregate demand (AD)?

Answer 1

The total amount of planned spending on goods and services at a given price level in an economy in a year.

Question 2

What are the components of AD?

Answer 2

Consumption + Investment + Government expenditure + (Exports - Imports)

Question 3

What proportion of AD is made up by consumption?

Answer 3

60%

Question 4

What proportion of AD is made up by investment?

Answer 4

15%

Question 5

What proportion of AD is made up by government expenditure?

Answer 5

25%

Question 6

What proportion of AD is made up by net trade?

Answer 6

Insignificant amount (around 1%)

Question 7

What is the shape of the AD curve?

Answer 7

Downwards sloping.

Question 8

What causes movement along the AD curve?

Answer 8

Change in price level.

Question 9

What causes a shift in AD?

Answer 9

When any of C+I+G+(X-M) change.

Question 10

What is consumption?

Answer 10

Spending by households on goods and services.

Question 11

What 4 factors that influence consumption?

Answer 11

Disposable income - more disposable income, more consumption.

Interest rates - if interest rates fall, so does the cost of borrowing and therefore there is more of an incentive to consume.

Consumer confidence - if households feel secure in their jobs and about their futures then they are more likely to consume.

Wealth effects - as for example large assets like houses rise in value, individuals feel wealthier and are therefore more likely to spend.

Question 12

What is investment?

Answer 12

An increase in capital stock.

Question 13

What is gross investment?

Answer 13

Net investment + depreciation

Question 14

What is net investment?

Answer 14

Gross investment - depreciation

Question 15

What 4 factors that influence investment?

Answer 15

Rate of economic growth - when economic growth is high firms need to invest in capital to cope with demand.

Business confidence - if firms feel secure in their future they are more likely to invest.

Interest rates - when rates fall it is cheaper for firms to invest in capital therefore increasing incentive to do so.

Government - policy may lead to changes in taxation for firms. If, for example, corporation tax is cut, then firms are more likely to spend on capital.

Question 16

What is corporation tax?

Answer 16

A tax on firms’ profits.

Question 17

What 2 factors that influence government expenditure?

Answer 17

Trade cycle - government spending will change depending on where an economy is along the trade cycle. When in a recession, government expenditure automatically increases due to greater spending on state benefits.

Fiscal policy - government can use taxation and expenditure to influence economic activity.

Question 18

What are 4 factors that influence net trade?

Answer 18

Real incomes - when incomes rise there are more imports than exports occurring. There is also less incentive for firms to sell abroad so they sell domestically.

Exchange rate - when the pound is relatively strong, imports become more appealing and exports to other countries are less appealing as they cost more.

State of world economy - exports are heavily impacted by economic growth rates in other countries.

Non-price factors - demand for imports and exports may be impacted by factors such as: quality, reliability and transport costs.