2.2 Aggregate demand (AD)

Question 1

Aggregate demand

Answer 1

the total amount of spending on goods and services produced in an economy during a period of time.

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

Question 2

Consumption

Answer 2

total planned household spending

Question 3

Disposable income

Answer 3

the income that households have to devote to consumption and saving, taking into account payments of direct taxes and transfer payments

Question 4

Average propensity to consume

Answer 4

Proportion of income that households devote to consumption.

Question 5

Marginal propensity to consume (MPC)

Answer 5

Proportion of additional disposable income households would devote to consumption

Question 6

Marginal propensity to save (MPS)

Answer 6

Proportion of an increase in disposable income households would devote to saving

Question 7

Influences on consumption

Answer 7

Level of real disposable income

• Rise means inc. spending & MPC
• Rise due to cut in income tax

Wealth effects
Where changes in household wealth induces changes in wealth expenditure
Households experience an inc. in the value of their assets holdings e.g. inc. house prices. MPC increases as they have the security of their property.

Consumer confidence - expectations about state of economy
Job prospects/level of unemployment, future inflation, times of recession/falling house prices

Interest rates (monetary policy)
Increase in rate, inc. cost of borrowing, MPS higher

Time lags

Question 8

Define wealth and income

Answer 8

Wealth: Accumulation of assets

Income: represents a flow

Question 9

Investment

Answer 9

Expenditure undertaken by firms on capital goods.

Question 10

Gross investment

Answer 10

Total investment

Gross investment = net investment plus depreciation of old capital i.e. cost of invest to replace

Question 11

Net investment

Answer 11

Investment undertaken to increase a firms productivity capacity
Net investment = gross investment - capital depreciation
If net invest is +ve, firm will have higher prod. capacity & can meet rising demand in the future.

Question 12

Macro objectives, gdp growth, inflation unemployment, balance of payemnts, ntohing overly technical , ad and as diagram, analysisi of ad and as, look at stuff of multipler!!! 10 marker will be an assess questionIn

Answer 12

I quote stephan

Question 13

Influences on investment

Answer 13

• Business confidence & expectations
• Gov influence & regulations; taxes
• Interest rates
• Access to credit
• Improved technology

Question 14

Influences on investment:

Business confidence & expectations

Answer 14

Business confidence & expectations - overall state of economy

Expectations about future demand; high +ve outlook incentives investment i.e. at times of rapid economic growth as to exploit opportunities for profit or when expect high rate of return.

Keynes: ‘animal spirits’
instincts & emotions that influence people when making financial decisions, drives level of confidence in the economy

Expectations not only depend on state of domestic economy but international competitiveness (exports make up for lack of demand domestically)

Rate of economic growth

Question 15

Influences on investment:

Government influence & regulations

Answer 15

Government influence & regulations

Gov has interest in encouraging investment; expands economy prod. capacity & economic growth

• Provide incentives as tax concessions
• Uses regulation to influence location/pattern of investment

Inflation could be damaging for economy

• high rate of inflation, inc. uncertainty for future
• dampen expectations, discourage investment.

Corporation tax; tax on firms’ profits

• lower corporation tax, higher retained profit
• use retained profits to invest

Question 16

Retained profit

Answer 16

Profit left after corporation tax has been paid

Question 17

Influences on investment:

Interest rates

Answer 17

Rate of interest represents cost of borrowing

• if firms need to borrow & interest rates are high, they will be discouraged from investing
• marginal propensity to invest (MPI) decreases
• AD shifts left

BUT: firms can use retained profits to fund investment

• face opportunity cost
• profits can be used to buy financial assets that will provide a rate of return dependant on rate of interest

Question 18

Influences on investment:
Access to credit
and improved technology

Answer 18

Bankers & lenders willingness to lend

• after financial crisis banks became more risk averse.
• ability of banks to provide credit depends on households who provide bank deposits through saving activity.

Improved technolgy;
inc. productivity/imporved quality

Question 19

Types of government spending

Answer 19

Gov spend to influence economic activity

Injections, shift AD to right:

• Current spending e.g. public sector wages
• Capital spending e.g. infrastructure
• Welfare spending e.g. benefits & pensions (JSA)

Doesn’t
- Debt interest payments

Question 20

Define budget deficit, surplus and national debt

Answer 20

Budget deficit: G > Taxation revenue in a fiscal year (April to April); borrowing in one year, after one year returns to zero

Budget surplus: G < Taxation revenue in one fiscal year

National debt: total stock of debt overtime. accumulation of budget deficit

Question 21

Influences on government spending

Answer 21

The business/trade cycle
Recessions
- Gov inc. spending to stimulate economy
- spending on welfare payments, help people who’ve lost jobs
- cut taxes, lose revenue
- inc. gov deficit to finance this

Periods of economic growth

• Gov receive more tax revenue
• Consumers spend & earn more
• Gov. spend less, economy doesn’t need stimulating
• fewer people claim benefits

Fiscal policy - demand side policy (works by influencing level the level/composition of AD)
Involves changing gov spending & taxation
gov might spend on public goods, merit goods & welfare payments
Recession: expansionary
Economic growth: contractionary

Question 22

Influences on net exports

Answer 22

Net exports (X-M)

Real disposable income earned abroad - 
State of world economy
- inc. exports as MPC abroad increases
- shift AD right
Recession - shift AD left

Real disposable income earned home - real income

• increase imports if increases
• AD shift left

Exchange rates
SPICED & WIDEC
Depreciation of £
- more competitive
- against dollar/euro more sig effect than country’s that aren’t major UK trading partners
- imports are more expensive, exports cheaper
- current account deficit narrows
Demand for UK exports must be elastic else price change will not impact

Degree of protectionism
- Act of guarding a country’s industries from foreign comp.
- tariffs, quotas, regulations, EMBARGEOS (economic) sanctions
UK employs protectionist measures
- trade def decreases
- protectionism leads to retaliation

Non-price factors
Competitiveness of country's goods & services, influenced by supply-side policies, impacts how many exports the country sells.
Become more comp, by being innovative
- higher qual g&s
- operate in niche market
- lower labour costs
- be more productive
- better infrastructure
(all increase exports) ^
Trade deals & trading blocs (being part of trading blocs)
- influences how much a country exports
- either opens up a country a closes a country from sig. export opps.