2.2 - Aggregate Demand

Question 1

Aggregate Demand

Answer 1

The total demand for goods and services in an economy at a given price level over a period of time

Question 2

Formula for Aggregate Demand

Answer 2

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

Question 3

Components of Aggregate Demand

Answer 3

1. Consumption
2. Investment
3. Government spending
4. Net exports

Question 4

Axis for an Aggregate Demand curve

Answer 4

1. Price level (Y-Axis)
2. Real Gross Domestic Product (X-Axis)

Question 5

Income effect

Answer 5

As a rise in prices is not matched straight away by a rise in income, people have lower real incomes so can afford to buy less, leading to a contraction demand

Question 6

Substitution effect

Answer 6

If prices in the UK rise, less foreigners will want to buy British
exports and more UK residents will want to buy imported foreign goods because they are cheaper. The rise in imports and fall of exports will decrease net exports so aggregate demand will contract

Question 7

Real balance effect

Answer 7

A rise in prices will mean that the amount people have saved
up will no longer be worth as much and so will offer less security. As a result, they will want to save more and so reduce their spending, causing a contraction in Aggregate Demand

Question 8

Interest rate effect

Answer 8

Rising prices mean firms have to pay their workers more and so
there is higher demand for money. If supply stays the same, then the ‘price of money’ i.e. interest rates will rise because of this higher demand. Higher interest rates mean that more people will save and less will borrow and will also mean that businesses invest less, so Aggregate Demand will contract

Question 9

Disposable income

Answer 9

The amount of income left for individuals or households after paying taxes and receiving government transfers, available for spending or saving, reflecting the real purchasing power of consumers

Question 10

Marginal Propensity to Consume

Answer 10

The proportion of an additional unit of income that a consumer is likely to spend on goods and services, rather than saving

Question 11

Formula for Marginal Propensity to Consume

Answer 11

Change in consumption / Change in income

Question 12

Average Propensity to Consume

Answer 12

The proportion of total income that is spent on consumption

Question 13

Formula for Average Propensity to Consume

Answer 13

Total consumption / Total income

Question 14

Marginal Propensity to Save

Answer 14

The proportion of an additional unit of income that a consumer saves rather than spends

Question 15

Formula for Marginal Propensity to Save

Answer 15

Change in savings / Change in income

Question 16

Average Propensity to Save

Answer 16

The proportion of total income that is saved rather than consumed

Question 17

Formula for Average Propensity to Save

Answer 17

Total savings / Total income

Question 18

Influences on consumer spending

Answer 18

1. Interest rates
2. Consumer confidence
3. Wealth effects
4. Distribution of income
5. Tastes and attitudes

Question 19

Gross investment

Answer 19

The total amount spent on new capital goods, such as machinery, buildings, and equipment, in a given period, without accounting for depreciation

Question 20

Net investment

Answer 20

The total amount spent on new capital goods, after accounting for depreciation

Question 21

Formula for net investment

Answer 21

Gross investment - Depreciation

Question 22

Influences on investment

Answer 22

1. Rate of economic growth
2. Business expectations and confidence (Animal spirits)
3. Demand for exports
4. Interest rates
5. Influence of government and regulations
6. Access to credit
7. Technological change
8. Costs

Question 23

Influences on government expenditure

Answer 23

1. The trade cycle
2. Fiscal policy
3. Age distribution of the population

Question 24

How the trade cycle influences government expenditure

Answer 24

In a recession, the government may increase spending in order to increase demand to reduce unemployment. Government spending also automatically rises during a recession as they have to spend more on unemployment benefits. During booms, the government may decrease spending to decrease demand and reduce inflation

Question 25

How fiscal policy influences government expenditure

Answer 25

Fiscal policy is the decisions about government spending and taxes and it will depend on the priorities of the government. The level of government spending depends on what they lay out in their fiscal policy

Question 26

How age distribution of the population influences government expenditure

Answer 26

An ageing population leads to increased government expenditure on pensions, social care etc. whilst a young population leads to increased spending on education. The more dependents in the economy (the young and old), the higher government spending tends to be

Question 27

Net trade

Answer 27

The difference between a country’s exports and imports, so if exports exceed imports there is a trade surplus but if imports exceed exports there is a trade deficit

Question 28

Formula for net trade

Answer 28

Exports - Imports

Question 29

Influences on net trade balance

Answer 29

1. Real income 2. Exchange rates 3. State of the world economy 4. Degree of protectionism 5. Non-price factors 6. Prices

Question 30

How real income influences net trade balance

Answer 30

When real income in the UK is high, there tends to be increased imports as people demand more goods and services and the UK is unable to meet their needs. This will mean that net trade decreases. However, if an increase in real income is due to export-led growth then net trade will increase

Question 31

How exchange rates influence net trade balance

Answer 31

A strong pound makes imports cheap and exports dear because it costs foreigners more to buy pounds with their local currency. As a result, imports will increase and exports will decrease so net trade will decrease, but this depends on the elasticity of imports and exports

Question 32

How the state of the world economy influences net trade balance

Answer 32

If the UK’s main export country is doing well, then UK exports are likely to rise and so net trade is likely to rise

Question 33

How the degree of protectionism influences net trade balance

Answer 33

If there is high protectionism on UK exports in other countries, exports will decrease as it will be harder for UK firms to sell their goods in other countries. If there is high protectionism on imports into the UK, imports will decrease. If the UK imposes protectionist measures, other countries are likely to retaliate and therefore exports are likely to decrease

Question 34

How non-price factors influence net trade balance

Answer 34

Two non-price factors which affect net trade are quality and design and marketing. If UK goods are of a higher quality and design, exports will be high as foreign demand for UK goods will increase and imports will decrease as people will buy the British goods instead of foreign goods, meaning net trade will increase

Question 35

How prices influence net trade balance

Answer 35

High prices of UK goods will mean that the goods are less competitive compared to international goods since people make decisions partly based on price. This means the volume of exports will decrease and the volume of imports will increase