2.2 Aggregate Demand

Question 1

What is aggregate demand?

Answer 1

• Similar to GDP, it is the total planned real expenditure on a country’s goods and services produced within an economy in each time period
• AD= C+I+G+ (X-M)

Question 2

Describe an aggregate demand curve

Answer 2

• On the X-axis is Real GDP (Y)
• On the Y-axis is General Price Level (GPL)
• Line sloping downwards

Question 3

Why does the AD curve take this shape?

Answer 3

• As prices of goods and services go up, less money can be used to consume, invest and export, thus reducing real GDP

Question 4

What are other explanations for the downward sloping AD curve?

Answer 4

• Real income effect
• Balance of trade effect/wealth effect
• Interest rate effect

Question 5

What is the real income effect?

Answer 5

• As price levels fall, real value (value for money) rises, allowing consumers to buy more

Question 6

What is the balance of trade effect?

Answer 6

• A fall in relative price level of country X could increase the price of foreign produced goods and services, leading to an increase in exports and decrease in imports

Question 7

What is the interest rate effect?

Answer 7

• Price inflation is low, leading to central bank reducing interest rates. This provides less of an incentive to save, so more people consume and prices increase
• Depreciating exchange rates also occur, resulting in an improvement in exports

reduces value in exchange rate

Question 8

What are the main causes of shifts in aggregate demand?

Answer 8

• Change in real incomes and employment
• Changes in Government spending taxation and borrowing
• Changes in monetary policy, interest rates & credit supply
• Changes in external value of a country’s exchange rate
• Changes in rate of economic growth of trading partner nations
• Fluctuations in consumer & business confidence

Question 9

What is the difference between movement and shifting in an aggregate demand curve?

what do shifts cause?

Answer 9

• Movement refers to when there is changes in General Price Level
• Shifting is when there are changes in other factors

shifts cause a multiplier effect

Question 10

What were the 2 advantages of a benefit cap being introduced?

Answer 10

• Reduce Government spending on benefits
• Encourage people to work

Question 11

explain the contraction and expansion of AD

Answer 11

contraction of ad is rise in price level

expansion of ad is fall in price level

Question 12

what are the key factors that influence consumer spending?

Answer 12

-changes in real disposable income
-level of and changes in employment and job security
-consumer credit(affects willingness to borrow)
-consumer confidence
-the cost of servicing a mortgage(interest rates)
-change in price of assets (property shares) affects wealth
-expectation of future price change

Question 13

what contributes the most to consumption?

Answer 13

housing

Question 14

what is consumer confidence?

Answer 14

consumer confidence are surveys or measure changes in consumer attitude, including expectations of the economic situation and households own financial positions.

Question 15

what factors does consumer confidence depend on?

Answer 15

base interest rate- set by bank of England used by banks
Disposable income-income after tax and addition of welfare
FTSE 100-track share prices of the 100 largest companies listed on the London stock exchange.
Savings ratio-ratio of personal saving to household disposable income.

Question 16

what is MPC and how to calculate it?

what should government do with those of high mpc?

Answer 16

Marginal propensity to consume is the change in consumer spending arising from a change in disposable income.

change in consumption/change in income

goverment should target tax reduction on low income families with high mpc

Question 17

what is household savings?

Answer 17

saving is disposable income that is not spent.

Yd= c+s therefore s=Yd-c

Question 18

What is MPS and how to calculate it?

Answer 18

Marginal propensity to save is the change in spending because of a change in household disposable income

change in savings/change in income

Question 19

what is household saving ratio and how to calculate?

Answer 19

it measures amount of money that households have available to save.its measured as a percentage of total disposable income

savings/disposable income

Question 20

what are they key factors that influence household savings?

Answer 20

real interest rate-positive rate incentives saving.

Price expectation-if consumers expect price to fall ie deflation they may save more.

consumer confidence

trust in savings institutions-deposit guarntees

taxation of savings-saving schemes like isa are tax free
job security/unemployed

availability of credit

Question 21

what is household debt?

Answer 21

It’s when households borrow money using credit cards.

this is counted as dis-saving as their borrowing allows them to spend more than their current disposable income.

Question 22

what is investment?

Answer 22

its when firms spend money on capital goods to increase production.

Question 23

what factors influence the level of investment?

Answer 23

-Interest rates (firms finance investment by borrowing)
-Business confidence (determined by future expected profit and demand)
-corporation tax(retained profit after corporation tax)
-spare capacity(if greater MPI will decrease)
-level of competition(if competitors invest in capital r&d innovation)
-the price of capital

Question 24

why does business confidence affect the level of investment?

Answer 24

Business confidence is determined by future expected profit and demand. If both are high I will increase.

Question 25

what is corporation tax?

and what is retained profit?

Answer 25

corporation tax is for firms and taxes its retained profit.

retained profit is profit after corporation tax.

Question 26

how does the level of competition affect investment?

Answer 26

if competitors invest in capital r&d and innovate products with the latest technology then firms would need to invest in capital to keep up with the advancements.

Question 27

what is the accelerator effect?

Answer 27

its when there is an increase in the rate of real GDP in the economy which then encourages investment.

Question 28

what are the types of goverment spending?

Answer 28

-current spending(it is the spending for maintenance of public services and payment of public sector wages.

-capital spending(its the spending on infrastructure)

-welfare spending (the spending on benefits and pensions. makes up most of gov spending.

-Debt interest payments(withdrawal)

Question 29

what is a budget deficit?

Answer 29

its when government spending is greater than the taxation revenue in a fiscal year (amount of borrowing in one year)

Question 30

what is a budget surplus?

Answer 30

its when taxation revenue is greater than government spending in a fiscal year.

Question 31

what is national debt?

what is the link to the national debt and budget deficit?

Answer 31

national debt is the total stock of debt.
its the accumulation of budget deficit.

Question 32

what are the main influences on net trade (x-m)?

Answer 32

-real disposable income earned abroad

-real disposable income earned at home

-strong or weak exchange rates(spiced widec)

-relative inflation levels at home)

Question 33

how does real disposable income earned abroad and at home influence net trade?

Answer 33

if people living abroad earn more than their marginal propensity to import goods increases. unless recession happens it will decrease.

If there is a boom in the UK, the marginal propensity to import will increase. Import expenditures will increase, which causes the economy to go left. If a recession happens, imports will decrease.

Question 34

how does relative inflation levels at home influence net trade?

how does it impact imports?

Answer 34

high relative inflation in the UK reduces export competitiveness and reduces export revenue AD will shift left.

if relative inflation in the UK is lower export demand will increase from other countries.

if relative inflation in UK is higher imports become competitive, and import expenditure will increase. VISE VERSA

Question 35

what is gross investment?

Answer 35

is the total amount of spending on capital goods

This spending includes replacing old capital goods and purchasing new capital goods

Question 36

what is net investment?

Answer 36

net investment = Gross investment minus capital consumption(depreciation)

some investment is needed each year to replace worn out machinery.

Question 37

what is fiscal policy?

Answer 37

It is what the government lays out to decide where money is spent and how much

Question 38

what is expansionary fiscal policy and also contractionary?

Answer 38

expansionary fiscal policy is when the government increases spending or reduces taxes to stimulate economic activity though this causes a budget deficit.

Contractionary is when the government reduces spending or increases taxes to control inflation and rein in the overheating economy. cause budget surplus but ad shifts left.

Question 39

how does trade cycle impact gov spending?

Answer 39

gov need to make decisions over expenditure to regulate AD and the trade cycle.

In recession, G might increase to increase demand for jobs and support those through benefits.

in a boom, G may decrease to reduce spending and inflation