2.2 Aggregate demand (AD)

Question 1

What is AD?

Answer 1

Aggregate demand (AD) is the total demand for all goods/services in an economy at any given average price level.

Question 2

How is AD calculated?

Answer 2

AD = Consumption (C) + Investment (I) + Government spending (G) + (Exports-Imports) (X-M)

Question 3

If AD increases, then …

Answer 3

economic growth has occurred.

Question 4

What does ‘net exports’ mean?

Answer 4

The difference between the revenue gained from selling goods/services abroad and the expenditure on goods/services from abroad

Question 5

For what 3 reasons does AD curve downward?

Answer 5

Interest rate effect, wealth effect, exchange rate effect

Question 6

What is the interest rate effect?

Answer 6

At higher average price (AP) levels, there are likely to be higher interest rates. Higher interest rates reduce investment and are an incentive for households to save - and vice versa.

Question 7

What is the wealth effect?

Answer 7

As AP increases, the purchasing power of households decreases and the AD falls - and vice versa.

Question 8

What is the exchange rate effect?

Answer 8

As AP falls, interest rates are likely to fall too. Lower interest rates lower the exchange rate. With a lower exchange rate, the economy’s goods/services are more attractive abroad and exports increase, thereby increasing real GDP

Question 9

What does an increase in any one of the determinants of AD do to the curve?

Answer 9

A right shift (vice versa for a decrease in AD)

Question 10

What does disposable income do to consumption?

Answer 10

Increases

Question 11

Describe the relationship between savings and consumption.

Answer 11

More savings, less consumption.

Question 12

Describe the effect interest rates can have on consumption.

Answer 12

If interest rates increase there is a higher incentive to save, and in turn loans/mortgages will increase (less consumption)

Question 13

State the effect consumer confidence will have on consumption and what could affect confidence.

Answer 13

Stronger economy: more confidence.
Secure jobs: more confidence.
Recessionary economy: less confidence.

Question 14

What effect would changes to wealth do to consumption? What would rising property prices give consumers?

Answer 14

Increases consumption.
Rising property prices give consumers confidence to borrow more money.

Question 15

What is the definition of investment?

Answer 15

Spending on capital goods from firms.

Question 16

What is depreciation?

Answer 16

The decrease in monetary value of a capital good (asset) over time.

Question 17

Difference between gross and net investment?

Answer 17

Gross investment is the total amount of spending on capital goods, net investment is the gross investment subtract depreciation

Question 18

What 4 influences may there be to investment?

Answer 18

Rates of economic growth, interest rates, demand for exports, influence of government/regulations.

Question 19

What did Keynes say on firms’ optimism?

Answer 19

Firms are too optimistic in good times and will take too many risks.

Question 20

What effect would access to credit have on investment?

Answer 20

The easier the access to loanable funds, the higher the levels of investment.