2.2.1 Characteristics of AD

Question 1

What is aggregate demand (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).
C + I + G + (X - M)

Question 3

What happens if AD increases?

Answer 3

If AD increases then economic growth has occurred and vice versa.

Question 4

Explain what consumption (C) is?

Answer 4

Consumption is the total spending on goods/services by consumers (households) in an economy.

Question 5

Explain what investment (I) is?

Answer 5

Investment is the total spending on capital goods by firms.

Question 6

Explain what government (G) is?

Answer 6

Government spending is the total spending by the government in the economy: Includes public sector salaries, payments for provision of merit and public goods etc. It does not include transfer payments.

Question 7

Explain what net exports (X - M) is?

Answer 7

Net exports are the difference between the revenue gained from selling goods/services abroad and the expenditure on goods/services from abroad. Individuals, firms and governments export/import.

Question 8

What does the X stand for?

Answer 8

Exports.

Question 9

What does the M stand for?

Answer 9

Imports.

Question 10

What is the approximate % of consumption?

Answer 10

60%

Question 11

What is the approximate % of investment?

Answer 11

14%

Question 12

What is the approximate % of government spending?

Answer 12

25%

Question 13

What is the approximate % of net exports?

Answer 13

1%

Question 14

What 3 reasons is the AD curve downward sloping?

Answer 14

/The interest rate effect
/The wealth effect
/The exchange rate effect

Question 15

Explain the interest rate effect?

Answer 15

The interest rate effect: 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 16

Explain the wealth effect?

Answer 16

The wealth effect: As AP increases, the purchasing power of households decreases and the AD falls - and vice versa.E

Question 17

Explain the exchange rate effect?

Answer 17

The exchange rate effect: 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.