2.2.1 Characteristics of Aggregate Demand

Question 1

What are the Components of Aggregate Demand (AD)?

Answer 1

Consumption: This is the spending by households on goods and services. It is influenced by factors like income, interest rates, and consumer confidence.

Investment: refers to spending by businesses on capital goods, such as machinery, buildings, and technology. It is influenced by interest rates, business expectations, and government policies.

Government Spending: This represents government expenditure on public goods and services, such as education, defense, and infrastructure.

Net Exports (X - M): This accounts for the difference between a country’s exports (X) and imports (M). A positive value indicates a trade surplus, while a negative value indicates a trade deficit.

Question 2

What is The Relative Importance of the Components of AD?

Answer 2

Consumption (C): In many economies, consumption is the largest component of AD. It tends to be stable and less volatile than other components. (61% in UK)
Investment (I): Investment can be highly volatile, especially during economic downturns when businesses may delay or reduce capital expenditures. (15% in UK)
Government Spending (G): Government spending can be used as a policy tool to stabilize the economy during recessions and boost AD. (23% in UK)
Net Exports (X - M): In open economies, the balance of trade can significantly impact AD. Countries with trade surpluses contribute positively to AD, while those with trade deficits detract from AD. ( Net exports: 1% in UK)

Question 3

What is the Distinction Between a Movement Along and a Shift of the AD Curve?

Answer 3

Movement Along the AD Curve: This occurs when there is a change in the price level (P) while other factors affecting AD remain constant. A change in P leads to a change in the quantity of Real GDP demanded, but the AD curve itself does not shift.

Shift of the AD Curve: This occurs when factors other than the price level change, leading to a shift in the entire AD curve. These factors include changes in consumer spending, business investment, government spending, or net exports.