2.2.1 The characteristics of Aggregate Demand

Question 1

What is Aggregate Demand (AD) made up of?

Answer 1

Consumption (C), Investment (I), Government spending (G) and Net exports (X-M)

AD = C+I+G+(X-M)

Question 2

Consumption

Answer 2

Consumption is consumer spending on goods and services; it makes up about 60% of AD

Question 3

Investment

Answer 3

Investment is spending by businesses on capital goods, such as new equipment; it makes up about 15-20% of AD

Question 4

Government Spending

Answer 4

Government Spending is spending by the government on providing goods and services; it tends to be around 18-20% of GDP

Question 5

Net exports

Answer 5

Net exports is exports minus imports.

The UK has a large trade deficit, but this minor figure and is the least significant part of AD at around 5%.

Question 6

What relationship does the AD curve show?

Answer 6

The AD curve shows the relationship between price level and real GDP

Question 7

How are movements along the AD curve caused?

Answer 7

A change in prices, caused by inflation or deflation

Question 8

How are shifts of the AD curve caused?

Answer 8

A change in any component of AD

Question 9

Why is AD downward sloping?

Answer 9

• Higher prices lead to a fall in the value of real incomes, so goods and services become less affordable in real terms
• If there was high inflation in the UK so that the average price level was high, foreign goods would seem relatively cheaper. Therefore, there would be more imports, so the deficit on the current account might increase, and AD would fall.
• High inflation generally means the interest rates will be higher. This will discourage spending, since saving becomes more attractive and borrowing becomes expensive.