2.2 Aggregate Demand

Question 1

What is Aggregate Demand (AD)?

Answer 1

The total level of spending in the economy at any given price

AD is composed of consumption, investment, government spending, and net exports.

Question 2

What is the formula for Aggregate Demand?

Answer 2

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

C = consumption, I = investment, G = government spending, X = exports, M = imports.

Question 3

What percentage of Aggregate Demand does consumption represent?

Answer 3

About 60%

Consumption is the largest component of AD.

Question 4

What is investment in the context of Aggregate Demand?

Answer 4

Spending by businesses on capital goods, such as new equipment and buildings

Investment makes up about 15-20% of AD.

Question 5

What is government spending in relation to Aggregate Demand?

Answer 5

Spending by the government on providing goods and services, generally public and merit goods

Government spending typically accounts for around 18-20% of GDP.

Question 6

What does net exports represent in Aggregate Demand?

Answer 6

Exports minus imports

The UK has a large trade deficit, making net exports the least significant part of AD at around 5%.

Question 7

What does the AD curve represent?

Answer 7

The relationship between price level and real GDP

The AD curve is downward sloping.

Question 8

What is the income effect in relation to the AD curve?

Answer 8

A rise in prices leads to lower real incomes, causing a contraction in demand.

Question 9

What is the substitution effect?

Answer 9

If UK prices rise, foreign demand for British exports decreases, leading to a contraction in AD.

Question 10

What is the real balance effect?

Answer 10

A rise in prices reduces the value of savings, leading to decreased spending and a contraction in AD.

Question 11

What causes movements along the AD curve?

Answer 11

Changes in price levels, caused by inflation or deflation.

Question 12

What distinguishes a shift in the AD curve from a movement along it?

Answer 12

A shift is caused by a change in any variable other than price.

Question 13

What is disposable income?

Answer 13

The money consumers have left to spend after taxes and state benefits

It significantly influences consumption levels.

Question 14

What is the marginal propensity to consume (MPC)?

Answer 14

The proportion of additional income that is spent on consumption.

Question 15

What is the average propensity to consume (APC)?

Answer 15

The average amount spent on consumption out of total income.

Question 16

What is the relationship between savings and consumption?

Answer 16

An increase in consumption decreases savings.

Question 17

What are interest rates’ effects on consumer spending?

Answer 17

High interest rates increase the cost of credit and reduce consumption.

Question 18

What influences consumer confidence?

Answer 18

Expectations about future economic conditions, inflation, and employment

High confidence generally leads to increased consumption.

Question 19

What is the wealth effect?

Answer 19

Increased wealth leads to greater consumption levels.

Question 20

What is gross investment?

Answer 20

The total amount of investment without accounting for depreciation.

Question 21

What is net investment?

Answer 21

Gross investment minus the value of depreciation.

Question 22

What factors influence business investment?

Answer 22

[”* Rate of economic growth”, “* Business expectations and confidence”, “* Demand for exports”, “* Interest rates”, “* Government regulations”, “* Access to credit”, “* Retained profit”, “* Technological change”, “* Costs”]

Question 23

What role does government spending play in Aggregate Demand?

Answer 23

It significantly influences the level of AD through spending on public services.

Question 24

What is fiscal policy?

Answer 24

Government policy regarding taxation and spending that can influence economic activity.

Question 25

What is the main purpose of increasing government spending during a recession?

Answer 25

To increase demand and reduce unemployment

Government spending automatically rises during a recession due to increased unemployment benefits.

Question 26

What is fiscal policy?

Answer 26

Decisions about government spending and taxes based on government priorities

Fiscal policy varies each year and is outlined in the government budget.

Question 27

How does an ageing population affect government expenditure?

Answer 27

Increases spending on pensions and social care

A young population increases spending on education.

Question 28

What is net trade?

Answer 28

Total exports minus total imports.

Question 29

How does real income affect net trade?

Answer 29

High real income tends to increase imports, decreasing net trade

However, if the increase is due to export-led growth, net trade may increase.

Question 30

What happens to net trade when the pound is strong?

Answer 30

Imports increase and exports decrease, leading to a decrease in net trade.

Question 31

What is the effect of exchange rates on imports and exports?

Answer 31

A strong currency makes imports cheaper and exports more expensive

The elasticity of demand for imports and exports affects the overall value.

Question 32

How does the state of the world economy influence net trade?

Answer 32

If the UK’s main export country is doing well, UK exports are likely to rise.

Question 33

What is protectionism?

Answer 33

Attempts to prevent domestic producers from foreign competition

Involves tariffs, quotas, and technical barriers.

Question 34

What are non-price factors that affect net trade?

Answer 34

Quality, design, and marketing of goods

Higher quality and better marketing increase exports and decrease imports.

Question 35

How do high prices of UK goods impact net trade?

Answer 35

Decrease exports and increase imports, lowering net trade

Higher prices can result from higher inflation rates or lower productivity.

Question 36

Fill in the blank: The level of government spending depends on what they lay out in their _______.

Answer 36

[fiscal policy]

Question 37

True or False: An increase in real income always leads to an increase in net trade.

Answer 37

False

It depends on whether the increase is due to export-led growth.