2.2.1 + 2.2.2

Question 1

Aggregate Demand

Answer 1

total planned real expenditure on goods and services produced within a country in a given time period.
C+I+G+(X-M)

Question 2

aggregate demand curve shows a relationship between…

Answer 2

Aggregate Demand and the general price level, and real gdp

Question 3

Lower GPL =

Answer 3

expansion of AD = higher real GDP

Question 4

Higher GPL =

Answer 4

Contraction of AD = lower gdp

Question 5

why the AD Curve Slopes Downwards

Answer 5

• real income effect
• balance of trade effect
• interest rate effect

Question 6

Real income effect

Answer 6

As the price level falls, the real value of income rises, and consumers are able to buy more of what they want or need
– this is known as the real money balance effect or real income effect
- the change in income is due to the change in the price level

Question 7

Balance of trade effect

Answer 7

If UK price level rises, less demand from other counties for UK goods, so less goods exported, so net trade decreases and AD contracts

Question 8

Interest rate effect

Answer 8

High interest rates - more saving - less consumption - inward shift of AD

Question 9

Causes for fall in AD

Answer 9

• Fall in net exports (M>X)
• cut in real level of gov spending
• higher interest rates/ fall in the supply of credit from banking systems
• decline in household wealth and confidence

Question 10

Causes for increases in AD

Answer 10

• Depreciation in the value of the exchange rate
• Cuts in the rate of direct and indirect taxes
• Increase in house prices and share prices
• Expansion of supply of credit + lower interest rates

Question 11

External Shocks and Aggregate Demand

Answer 11

1. unexpectedly large rise or fall in the value of exchange rate.
2. A recession, slowdown or boom in a nation’s key trading partner countries.
3. A slump in the housing market / construction sector of a country heavily reliant on these industries
4. An event such as the Global Financial Crisis which caused a steep fall in the supply of credit available to businesses and households and which ultimately led to recession in many countries.
5. A large change in commodity prices for a country that is a commodity exporter or a net commodity importer

Question 12

External shock definition

Answer 12

unexpected economic events cause changes in demand, output and employment

Question 13

Consumption (C)

Answer 13

Consumption is spending on consumer goods and services

Question 14

Marginal Propensity to Consume (MPC)

Answer 14

Marginal propensity to consume is the change in spending following a change in income (ΔC/ΔY).
o receives extra pay of £2000 and spend £1500
o MPC is £1500 / £2000 = 0.75
o rest is saved so marginal propensity to save (MPS) is 0.25

Question 15

Factors that affect consumer spending

Answer 15

1. Real Disposable Income
2. Employment and Job Security: When labour market is improving, confidence and incomes improve.
3. Consumer Confidence: Uncertainty causes spending to fall, improving animal spirits will improve demand.
4. Market Interest Rates

Question 16

Importance of Consumer Confidence

Answer 16

CC surveys measures a range of consumer attitudes, including forward expectations of the economic
situation and households’ own financial positions, and their views on making major purchases such as a new car or home
improvements.
- Keynesian economists refer to this as animal spirits.

Question 17

Formula for saving in a CLOSED economy

Answer 17

Disposable income (yd) = Consumption + saving

yd = c + s

Disposable income - income after taxes and benefits

Question 18

Saving ratio

Answer 18

• saving ratio for households measures the amount of money households have available to save as a % of their total yd = the average propensity to save (APS).
  • If a person has income of £25,000 and saves £2500 of this, the savings ratio is 10%.

Question 19

Real interest rate

Answer 19

The nominal interest rate adjusted for inflation.

A positive real interest rate incentivises saving

Question 20

How Price Expectations affect level of household saving

Answer 20

If consumers expect prices to fall (i.e. deflation) they may choose to save more now

Question 21

How job security affects household saving

Answer 21

If unemployment rises = job security decreases = more people save more as a precaution

Question 22

How consumer confidence affects household saving

Answer 22

When consumer confidence is strong, people are more willing to spend/borrow and save less

Question 23

Importance of saving

Answer 23

• business survival
• funding investment
• buffer of financial resources for consumers

Question 24

Business survival

Answer 24

• Corporate savings provide a cushion during a recession when sales and revenues are falling.
• Business savings can be used as finance for takeovers and for capital investment projects.

Question 25

Funding investment

Answer 25

• Commercial banks need savings deposits from which they can lend to borrowers.
• Savings flow into pension funds – these can be reinvested in stock markets providing investment funds.

Question 26

Buffer of financial resources for consumers

Answer 26

• Savings can smooth consumption during tough economic times.
• They allow people to reduce their debts.
• Savings are a key source of retirement income i.e. they help to smooth consumption over one’s life.