2.2 Aggregate Demand

Question 1

Definition: Aggregate Demand

Answer 1

The total planned expenditure on goods and services produced in an economy over time.
C + I + G + (X-M)

Question 2

Components of AD
(UK specific)

Answer 2

• Consumption is the largest component of AD (~60%)
• Investment is an increase in the capital stock by increasing assets (~10-15%)
• Govt. Spending is money spent on the public sector. A small figure as a lot of spending is transfer payments which accounts for consumption (~20%)
• Net Trade decreases the value of AD as the UK is in a current account deficit due to the economy being a net importer.

Question 3

Shape of the AD curve

Answer 3

• Lower prices increases export competitiveness which consequently increases net trade
• When prices fall, people typically spend the same amount but get a larger volume of goods and services (Real Balance Effect)
• At higher price levels, the interest rates are typically raised, resulting in a fall in investment and consumption

Question 4

Factors affecting consumption

Answer 4

• Disposable income (influenced by govt. spending and fiscal policy)
• Savings ratio / Marginal Propensity to save (influenced by monetary policy/interest rates)
• Changes in wealth (wealth effect when asset prices rise, typicallly house prices)
• Consumer Confidence (influenced by domestic and global economic situations/events)
• Interest Rates (an increase can decrease demand for new house, lowering house prices leading to the negative wealth effect while also increasing mortgage costs, decreasing consumption.

Question 5

Definition: Animal Spirits

Answer 5

A term coined by Keynes that reflects the tendency for humans to make large changes based off small events. Explains the reason behind markets moving in large booms and busts due to humans acting impulsively.

Question 6

Factors affecting Investment

Answer 6

• Rate of Economic Growth (during times of growth, firms may look to invest to increase output)
• Business Confidence (better prospects increases investment as profit potential is higher)
• Demand for exports (when demand rises, firms are more likely to invest into markets where sales have increased)
• Interest rates/credit availability (when borrowing is cheaper/more accessible, investments are easier to finance)
• Govt. Regulation (can influence the sales and profits of firms, hence impacting their willingness and ability to invest)

Question 7

Accelerator Theory

Answer 7

The level of investment in an economy is driven by previous changes in national income. An increase in GDP results in a proportionally larger change in capital investment. (High Business confidence and more profit potential for firms given the higher demand)

Question 8

Definition: Transfer Payments

Answer 8

A payment made by the government in which no goods and services are bought (e.g. welfare payments)
Not included in government spending and are spent through consumption

Question 9

Current vs Capital Spending

Answer 9

Current spending is spending on short term goods and services that are quickly consumed

Capital spending is spending on capital assets that can be used multiple times over a long period

Question 10

Definition: Austerity

Answer 10

The reduction of government spending and an increase in taxation to slow down an increase in price level and/or reduce the govt. budget deficit.

Question 11

Economic Boom vs Recession

Answer 11

A boom is a period of rapid growth in real GDP where unemployment is low and the price level rises rapidly. (contractionary fiscal policy may be used to slow down the price level rise)

A recession is where there is a decrease in real GDP and negative economic growth over 2 consecutive quarters (expansionary fiscal policy may be used to stimulate economic activity)

Question 12

Automatic Stabilisers vs Discretionary Fiscal Policy

Answer 12

Automatic stabilisers are automatic fiscal changes that occur following a change in the rate of economic growth to achieve equilibrium. (e.g welfare payments)

Discretionary policy is action taken by the government to actively influence the rate of economic growth and inflation (e.g changing taxes and govt. spending)

Question 13

Factors affecting net trade
(UK specific)

Answer 13

• Consumer confidence (increased confidence results in an increase in the demand for imports)
• Higher real incomes (An increase in incomes boosts demand for exports as consumers are more likely to spend on foreign products)
• Exchange Rates/ Price level (changes can affect the price of imports/exports and affect their competitiveness)
• Global Economic Status (when the global economy is strong, international trade is high, negatively impacting importing countries and vice versa)
• Regulation (Policies on trade can affect the price and accessibility of imports/exports)
• Non-Price Factors (Changes in these factors can affect competitiveness of exports and domestic goods, affecting net trade)