2.2 - Aggregate demand

Question 1

Definition of aggregate demand (AD)

Answer 1

The total amount of goods and services demanded in the economy over a given period of time

Question 2

Equation of AD

Answer 2

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

Question 3

Definition of consumption

Answer 3

The total spending on goods and services in an economy over a given period of time

Question 4

What is disposable income

Answer 4

Income after tax

Question 5

What happens during a period economic boom?

Answer 5

Savings decrease as consumer confidence increases which causes a rise in consumption as consumers feel more financially secured as well as seeing a rise in income (GDP increases)

Question 6

What happens during a recession?

Answer 6

Uncertainty over the economic situation increases which worsens consumer confidence - this causes consumption to fall

Question 7

What are the factors influencing consumption?

Answer 7

1. Economic state
2. Interest rates - the decrease in the cost of borrowing causes consumer confidence to rise

-> mortgage rate falls which causes more consumers to buy more homes which in turn boosts consumption for furniture/home related goods

3. Wealth effect - the rise in the value of assets due to GDP growth causes consumer confidence to rise (positive wealth effect) which in turn causes consumption of goods to increase as homeowners feel more wealthy

Question 8

Definition of investment and gross investment

Answer 8

The total spending on capital stock in an economy over a given period of time

Total value of new physical capital that is produced/purchased in an economy
-> this includes both replacement investment (to maintain existing capital) and net investment (increase in capital stock)

Question 9

Influences in investment

Answer 9

1. Economic growth
2. Demand for exports
3. Interest rates
4. Access to credit / finance
5. Government / regulation
6. Animal spirits

Question 10

Case study of access to study

Answer 10

2008 financial crisis

Business faced difficulty over accessing finance due to frozen credit market - this lack of credit availability caused a significant drop in investment

Question 11

What is Animal spirits?

Answer 11

Keynes coined this term to describe the emotional factors influencing investment decisions - confidence, optimism and entrepreneurial spirit can drive investment even when rational analysis may advice to stay cautious

Question 12

Definition of government spending

Answer 12

The total expenditure of government’s budget in an economy over a period of time

Question 13

Factors influencing on government spending?

Answer 13

1. Trade (business) cycle
2. Fiscal policy

Question 14

What happens to government spending during a boom?

Answer 14

Government spending falls due to no need of stimulating the economy in fear of further inflationary pressure + unemployment falls (causes spending on welfare payments to fall as well)

Tax revenue rises as more people will be earning higher incomes (income tax), spending more (VAT) and firms earning higher profits (corporation tax)
This will help to reduce a budget deficit - this will help during times of recession to stimulate the economy

Question 15

What happens during a recession?

Answer 15

Government spending increases to try to stimulate more demand in the economy - e.g. increasing welfare payments (for greater consumption) and cutting taxes (encourage spending and investment)

This causes budget deficit to increase which conflicts with macroeconomic objective of a balanced government budget

Question 16

Definition of net exports

Answer 16

The difference between a country’s exports and imports