2.2.1 - The Characteristics of AD

Question 1

Define Aggregate

Answer 1

Sum or Total

Question 2

Define Aggregate Demand

Answer 2

.Total demand for a country’s good and services at given price level in a given time period

. AD is a measure of total expenditure on a country’s goods and services

Question 3

Equation for Aggregate Demand

Answer 3

Aggregate Demand = Consumption + Investment + Government Spending + Net Exports

Question 4

What does Aggregate Demand curve show?

Answer 4

The relationship between price level and real output / real expenditure

. There is an INVESRSE relationship between average price level and real GDP

Question 5

Explain Price Level (y axis) in Aggregate Demand

Answer 5

. The price level is the average level of prices in the economy

. If there is an increase in average price level, there is inflation

Question 6

How is average price level calculated?

Answer 6

. Through Consume Price Index

Question 7

What is real output equal to or the same as?

Answer 7

. Real Output equals real expenditure equals real income

Question 8

Define Consumption (C)

Answer 8

The spending by households on goods and services

Question 9

Define Investment (I)

Answer 9

The spending by firms on capital goods

Question 10

Define Government Spending (G)

Answer 10

.Includes current spending, for instance on wages and salaries

. Also includes spending by government on investment goods like new roads or new schools

Question 11

Define Exports minus Imports

Answer 11

. Net export means exports value - import value

Question 12

Parts of AD

Answer 12

. Consumption
. Investment
. Government Spending
. Net Exports

Question 13

Name three reasons why the AD curves slopes downwards

Answer 13

. Wealth Effect
. Trade Effect
. Interest Effect

Question 14

Explain Wealth Effect

(Reason for Downwards Slope)

(Causes Movement ALONG AD curve, so change in price)

Answer 14

. If the price level decreases, the purchasing power of people increases; they have more disposable income so they are richer; the marginal propensity to consume increases.

. They have more money to spend more on goods and services so consumption increases, meaning real GDP increases; there will be an expansion in real GDP

Question 15

Explain Trade Effect

(Reason for Downwards Slope)

(Causes Movement ALONG AD curve, so change in price)

Answer 15

. As the price level increases, the competitiveness of domestic exports decreases, due to a weaker purchasing power, reducing the marginal propensity to consume and hence reducing the demand and the revenues generated from the exports

. Furthermore, imports become more competitive when prices increases, increasing the demand for them and increasing expenditure.

. This leads to a contraction of AD as the value of net exports decreases

• The opposite occurs when price level decreases!

Question 16

Explain the interest effect

(Reason for Downwards Slope)

(Causes Movement ALONG AD curve, so change in price)

Answer 16

. As the price level increases, interest rates will rises to bring inflation back down towards the target (2%).

. High interest rates increases the cost of borrowing and the return on saving for both individuals and firms, which reduces the consumption and investment in AD

. Furthermore higher interest rates will strengthen the exchange rates, making exports dearer and imports cheaper, reducing the value of net exports in the AD equation. This means a contraction of AD

Question 17

What does a change in price do in the AD curve?

Answer 17

. A change in price leads to movement along the AD curve

. If price level increases, there will be an contraction in AD

. If price level decreases, there will be an expansion in AD

Question 18

When does a SHIFT in the AD curve occur?

Answer 18

A shift in the AD curve occurs if a there is an increase or decrease in the parts of AD, at SPECIFIC FIXED price level

. Parts of AD are C, I, G and (X-M)

. There OTHER reasons why C, I, G and (X-M) change