2.2 AGGREGATE DEMAND (AD)

Question 1

What is Aggregate Demand (AD0)

Answer 1

Total level of planned real expenditure on goods and services produced within a country in a given period of time.

Question 2

Formula for AD

Answer 2

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

Question 3

Components of AD

Answer 3

C - CONSUMER - Household spending on goods and services.

I - INVESTORS - Gross fixed capital investment spending and the value of the change in stocks.

G - GOVERNMENT SPENDING - Spending on public services.

X minus M - EXPORTS MINUS IMPORTS

Question 4

Aggregate Demand Relationship

Answer 4

The AD curve shows the relationship between AD and general price level. It is an inverse relationship.

Question 5

Movements Along The AD Curve

Answer 5

A rise in price causes a contraction of AD.

A fall in price causes an expansion of AD.

Question 6

Why AD Slopes Downwards?

Answer 6

REAL INCOME EFFECT - As the price falls, the real value of income rises, and consumers are able to buy more of what they need or want - this is known as the real money balance effect or real income effect.

BALANCE OF TRADE EFFECT - Fall in the relative price of level of country X could make foreign produced goods more expensive, causing a rise in exports and a fall in imports. The trade balance then simply improves.

INTEREST RATE EFFECT - If price inflation is low and this leads to a reduction in interest rates, there is less incentive to save and a fall in interest rates may cause the exchange rate to depreciate and improve export sales.

Question 7

Shifts In AD

Answer 7

FALL IN AD
- Fall in net exports (M higher than X)
- Cut in level of government spending
- Higher interest rates, fall in supply of credit so C decreases.
- Decline in wealth and confidence.

INCREASE IN AD
- Depreciation in the exchange rates.
- Cuts in taxes.
- Increase in house prices and share prices.
- Expansion in credit supply, lower interest rates.

Question 8

External Shock To AD

Answer 8

1- Dramatic movement of exchange rate.
2- A recession, slowdown or boom in a trading partner.
3- A slump in the housing market.
4- Steep fall in the supply of the available credit (2008)
5- Large change in commodity prices.

Question 9

Who Created AD?

Answer 9

John Maynard Keynes

Question 10

Gross Investment

Answer 10

The addition to capital stock that has been used up (depreciated) and the creation of additional capital stock.

Question 11

Net Investment

Answer 11

Net Investment = Gross Investment - Depreciation

Question 12

Influences Of Investment

Answer 12

• Interest rates
• Rate of economic growth (accelerator theory)
• Costs - Minimum wage increase, Geo Location, Scarcity, Oil prices.
• Business confidence, “animal spirits”
• World economy
• Access to credit
• Retained profit
• Influence of government

Question 13

What is “animal spirits”?

Answer 13

Theory by Keynes.

Animal spirits refer to the ways that human emotion can drive financial decision-making in uncertain environments and volatile times.

Question 14

What do government spend money on?

Answer 14

• The trade cycle (have to spend more in a recession)
• Fiscal policy (decisions about gov spending, taxes and borrowing)

Question 15

Net Trade Balance

Answer 15

• Real income in the domestic economy
• Exchange rates - SPICED Strong Pound Imports Cheaper Exports Dearer
• State of world economy
• Degree of protectionism (quotas or tariffs)