2.2 Aggregate Demand (AD)

Question 1

Aggregate demand (components of AD)

Answer 1

= total amount of spending on goods & services produced in an economy during a period of time

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

(Consumption + Investment + Government Spending + (Exports - Imports)

Question 2

Consumption

Answer 2

Consumer spending on goods & services

• makes up about 65% of AD (largest component)

Question 3

Investment

Answer 3

Spending by businesses on capital goods (new equipment / buildings)
& working capital (stocks)

Most investment by private sector (75%) but some by gov

Makes up around 15-20% of AD

Question 4

Government spending

Answer 4

Spending by gov on providing goods & services (on wages, salaries of public sector workers, investment goods eg. Roads, schools)

Makes up around 20% of AD

Question 5

Net exports

Answer 5

= exports - imports

Negative balance of trade in goods & services rn (trade deficit in UK)

Makes up around 5% of AD (smallest component)

Question 6

The AD curve (and why is it downwards sloping)

Answer 6

• the wealth effect (fall in price level, gives consumers perception they’re wealthier as purchasing power increases so consumers spend more (increase in real GDP)
• increased export revenue (decrease in general price level make exports cheaper so export revenue increases so real GDP increases)
• lower interest rates (as price level / inflation decreases interest rates usually fall too, encourages consumer consumption & increase in investment so real GDP increases)

Question 7

Gross vs net investment

Answer 7

Gross investment = measures investment without taking into account depreciation

Net investment = (takes into account depreciation of capital) gross investment - value of depreciation

Machinery depreciates (loses value) over time as it gets used up

Question 8

relationship between savings and consumption

Answer 8

inverse relationship

Marginal propensity to consume (MPC) = how much of consumers extra income is spent (1 means all consumer extra income spend and 0 means all saved)

MPS (marginal propensity to save) = how much of an increase in income is saved

APS (average propensity to save) = average amount saved out of income

Question 9

Influences on investment

Answer 9

• rate of economic growth (firms know demand will increase so invest in capital goods to maximise future profits)
• business expectations & confidence (if know demand will increase marginal propensity to invest increases)
• Keynes & ‘animal spirits’ (links psychological changes to spending/investment eg. strong economic growth = strong animal spirits (entrepreneurs willing to take risks))
• demand for exports (firms increase investment in capital goods to increase productive potential & more profit for investment)
• interest rates (lower interest rates so more borrowing bank loans so more investment)
• access to credit (during recessions, banks less likely to loan money to firms as increased risk so less investment)
• influence of gov & regulations (lower corporation tax or grants to encourage investment, planning regulations decrease investment)

Question 10

Main influences on government expenditure

Answer 10

• trade cycle (during recessions = increased spending to increase demand & reduce unemployment / unemployment benefits, during boom = increase spending to decrease demand & reduce inflation)
• fiscal policy (demand side policy, changes in gov spending & taxation to influence level of AD, contractionary (reduces AD) or expansionary (increases AD)
  2 types:
  Discretionary (implemented through policy changes / gov actions)
  Automatic stabilisers (policies to offset fluctuations in economic cycle that dont require gov intervention)

Question 11

Influences on net trade balance

Answer 11

• real income (high income = increased imports = net trade decreases, export-led growth in income = net trade increases)
• exchange rates (strong pound = cheaper imports, dearer exports = imports increase, exports decrease = net trade decreases, depends on PED of imports & exports)
• state of world economy (UK’s export countries economies doing well = rise in exports = net trade increase, depends on trade relationships)
• degree of protectionism (tariffs, quotas introduced to protect domestic producers from competition abroad, high protectionism in exports = net trade decreases)
• non-price factors (high quality design & marketing of UK goods = export high = net trade increases, more inelastic)

Question 12

Distinction between movement along & shift of AD curve

Answer 12

Change in general price level of goods/services within economy = movement AD curve

Change in value of components of AD = shift in AD curve

(anything but price then shift)

Question 13

Influences on consumer spending

Answer 13

Disposable income: income individual receives are paying all taxes & receiving any transfer payments (money available for consumer to spend) more income so increase in spending so increased consumption within economy so increase in AD

Interest rates: decrease in interest rates reduces cost of borrowing so more likely to take out loans & less incentive to save as low return on savings so more consumption

Consumer confidence: marginal propensity to consumer increases with consumer confidence, (feel more secure in job if low unemployment) so wont save as much so increase in consumption

Wealth effects: changes in economy make consumers wealthier (increase in house/share prices), so more financially confident to encouraged to spend more to sell their wealth (stocks) at higher prices (in boom) so more money to spend to increase in consumption