2.2 AND 2.3

Question 1

what is meant by aggregate demand

Answer 1

the total level of real expenditure on the goods and services produced within a country

Question 2

what are the components of aggregate demand

Answer 2

• household consumption - C (consumption
• Gross Fixed Capital Investment Spending by firms - I (investment)
• government consumption - G (public services)
• exports of goods and services - X
• imports of goods and services - M

Question 3

what is the formula for aggregate demand

Answer 3

C + I + G + (X - M)

Question 4

what is the approximate figure of consumption spent in an economy, investment and government

Answer 4

consumption - 65%
investment - 16%
government - 15%
Exports - imports = remainder - 4%

Question 5

What is meant by real disposable income

Answer 5

Income adjusted for inflation - tax + benefits

Question 6

What is meant by average propensity to consume

Answer 6

The proportion of income that is spent

Household consumption
—————————————- x 100
Income

Question 7

What is meant by marginal propensity to consume

Answer 7

The change in consumer spending following a change in income

Question 8

What is meant by savings ratio

Answer 8

% of income that is saved

Question 9

what is meant by interest rate

Answer 9

the cost of borrowing or the reward of saving

Question 10

what happens when interest rates rise

Answer 10

consumption falls, and savings rise

Question 11

what is meant by consumer confidence

Answer 11

measures how optimistic households feel about the future

Question 12

what does an AD curve show?

Answer 12

it shows how much of a good will be consumed at each and every price level

Question 13

why is an AD curve down sloping?

Answer 13

1. the wealth effect
2. the interest rate effect
3. the exchange rate effect

Question 14

what is meant by the wealth effect

Answer 14

When people spend more because the value of their assets increase

Question 15

what is meant by the interest rate effect

Answer 15

as the price level rises, the level of real income falls, and consumers are less likely to save their income. if the levels of savings falls, then the funds available for investment also falls, pushing up the interest rate.

Question 16

what is meant by the exchange rate effect

Answer 16

as the price level rises, UK exports look less competitive compared to foreign goods, so exports falls and imports rise. This means that net exports falls, and spending in the economy also falls.

Question 17

what would cause a movement along the AD curve?

Answer 17

an increase or decrease in the price level

Question 18

what would cause a shift in the AD curve?

Answer 18

a change that affects any of the components of AD

Question 19

name five factors that increase consumption

Answer 19

• real incomes rising
• interest rates falling
• asset prices/wealth
• job security/confidence
• personal taxation falling

Question 20

define investment

Answer 20

the purchase of fixed capital such as machinery

Question 21

what is depreciation of capital?

Answer 21

when capital loses value over time due to wear and tear, or it becomes obselete (eg end of products lifespan)

Question 22

distinguish between investment and net investment

Answer 22

capital needs to be replaced otherwise the value of capital stock in the economy will start to fall down due to depreciation. net investment is investment over and above the amount of investment needed to replace depreciated capital

Question 23

name 7 factors that increase investment

Answer 23

lower interest rates
high animal spirits
demand for exports rises
business expectation and confidence
access to credit improves
lower corporation taxes and business regulations
high rate of economic growth

Question 24

define government expenditure

Answer 24

in the context of AD, it refers to government purchasing of goods and services, for examples paying for hospitals

Question 25

distinguish between government spending and government expenditure

Answer 25

government spending in the wider context includes spending on transfer payments where nothing is expected in return such as pensions and welfare payments.

Question 26

define fiscal policy

Answer 26

taxation and spending

Question 27

name three fiscal policies

Answer 27

income tax falling VAT rising corporation tax falling

Question 28

what is meant by a budget deficit

Answer 28

when government spending is greater than tax revenue.

Question 29

how does the trade cycle affect government spending

Answer 29

during a recession government spending increases as more people claim unemployment benefits etc. also, the government often deliberately runs a deficit in order to stimulate the economy

Question 30

define exports

Answer 30

selling UK produced goods and services abroad, and currency flows in to the UK

Question 31

define imports

Answer 31

buying goods and services produced abroad, currency flowing out of the UK

Question 32

what is meant by net exports

Answer 32

exporting more than importing ( X>M )

Question 33

define exchange rate

Answer 33

the rate at which one currency is exchanged for another

Question 34

how does domestic inflation affect net exports

Answer 34

prices rise domestically, the UK exports look less competitive compared to similar goods produced by other countries, so net exports would fall

Question 35

how does a global recession affect exports?

Answer 35

a global recession such as the one following the global financial crisis in 2008 causes demand for UK exports to fall

Question 36

how does the domestic business cycle affect imports

Answer 36

during a uk recession consumption of all goods and services falls including imports

Question 37

what is meant by protectionism and give examples

Answer 37

when a country uses barriers to trade to protect domestic industry, eg - tariffs - tax on imports - quotas - limits placed on the number of goods that can be imported

Question 38

draw a standard Aggregate Supply curve

Answer 38

upward sloping GPL y axis Real GDP x axis equiilibrium at GPL1 and Y1

Question 39

why is the AS curve sloping

Answer 39

it measures the volume of goods and services produced every year and so measures the ability of the economy to produce them to meet the level of demand in the economy. in the short run, we assume that the price level can change, but factors of production are fixed. the curve is upward sloping because an increase in the price level makes production more profitable and gives firms an incentive to increase output

Question 40

what factors cause a movement along the AS curve and what factors cause a shift in the AS curve

Answer 40

changes in the price level causes a movement along | changes in the costs of factors of production shifts the SRAS curve.

Question 41

what is the relationship between short run and long run supply

Answer 41

LRAS shows the productive potential of the economy, SRAS holds the long run variables constant, such as productivity and technology.

Question 42

identify and explain three factors that affect SRAS

Answer 42

increase in the wage rate - increases cost of production for firms, reduces profitability and so decreases SRAS increase in VAT - '' commodity prices - ''

Question 43

draw a Keynesian AS curve

Answer 43

curve goes from horizontal to upward sloping | two AD curves AD1 and AD2 upwards on AS curve

Question 44

draw a classical LRAS curve

Answer 44

two vertical LRAS lines, two AD curves. equilibrium at LRAS 1 at P1 and Y1

Question 45

define spare capacity

Answer 45

when the factors of production are not working as hard as they could under normal working conditions

Question 46

what part on the Keynesian AS curve represents spare capacity?

Answer 46

the flat part - resources arent scarce yet, so output can increase without it being inflationary.

Question 47

what other diagrams show spare capacity

Answer 47

PPFs - a point on the PPF, and the economic cycle graph - during a recession

Question 48

why is the Keynesian LRAS curve the shape it is?

Answer 48

flat part is the spare capacity the upward sloping part is because there is an increase in output which causes the price level to rise, as labour becomes scarce and wages rise, and then it goes vertical at the maximum capacity in the economy.

Question 49

why is the classical LRAS curve the shape it is?

Answer 49

output can only be increased if the whole LRAS shifts to the right, eg if there was an increase in productivity or tech improved. the LRAS shows the maximum capacity of the economy, with the given state of technology, and also that all factors of production are fully and efficiently used

Question 50

explain 6 factors that would shift the LRAS

Answer 50

``` increase in the working population increase in quality of labour improvement in technology increase in productivity net investment increasing capital stock infrastructure improves ```