2.2.3 + 2.2.4 The determinants of aggregate demand

Question 1

components of AD

Answer 1

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

Question 2

consumption definition

Answer 2

Consumer spending on real output; spending on non-durables, durables & services; the largest component of AD, usually about 60%.

Question 3

factors influencing consumption

Answer 3

• Income: more consumer spending.
• Wealth effect
• Consumer confidence: high confidence leads to more consumer spending.
• Job security
• Interest rates: affect the cost of borrowing
• Demography: a growing population (e.g. immigration) spending more

Question 4

benefits of rising consumption

Answer 4

• rising AD
• faster SR economic growth
• falling umeployment
• more business confidence to invest
• less spare capacity

Question 5

costs of rising consumption

Answer 5

• inflation pressure
• CA deficit
• unbalanced growth
• more household debt
• environmental issues

Question 6

savings ratio

Answer 6

total household savings// total household disposable income

Question 7

importance of savings for econ

Answer 7

Savings flow into financial markets and businesses can access these funds to invest
Provides households with a cushion of financial stability and funds for the government when it needs to borrow.

Question 8

paradox of thrift

Answer 8

Keyensian conomic theory which states that an increase in saving can lead to a decrease in economic activity and, ironically, a decrease in overall saving.

Question 9

investment definition

Answer 9

addition to capital stock of the economy e.g. factories, machines, offices, equipment, stocks of materials used to produce other goods

Question 10

Gross investment

Answer 10

investment before depreciation

Question 11

Net investment

Answer 11

gross investment – depreciation

Question 12

why do firms invest?

Answer 12

• expand business and increase output capacity
• reduce average costs
• increase efficiency and productivity
• increase competitivness

Question 13

factors influencing investment

Answer 13

• Interest rate: lower interest rate reduces the cost of borrowing
• Availability of finance
• Demand for the final product: incentive to expand
• Business confidence
• Corporate taxes
• Business regulation: a reduction in red tape and bureaucracy for businesses can incentivise more investment
• Technological change

Question 14

governemnt consumption

Answer 14

the day-to-day running costs of government

Question 15

role of gov spending

Answer 15

part of fiscal policy
* change level of AD (with fiscal multiplier)
* provide public and merit goods
* correct market failures, e.g. positive consumption externalities
* influence economic regions., e.g. ‘levelling up’
* achieve greater equity in society by providing public services, including universal access to healthcare and education.

Question 16

factors influencing net trade

Answer 16

• Real income
• Exchange rate: depreciation makes imports more expensive and exports cheaper, increase X-M
• State of global economy: strong global growth may increase demand for exports, increasing X-M
• Degree of protectionism
• Non-price competitiveness
• Price competitiveness

Question 17

multiplier effect

Answer 17

occurs when an initial injection into the circular flow causes a bigger final increase in real national income.

Question 18

negative mutliplier effect

Answer 18

ccurs when an initial withdrawal or leakage of spending from the circular flow leads to knock-on effects and a bigger final drop in real GDP.

Question 19

multiplier coefficient

Answer 19

itself is found by:
Final change in real GDP / Initial change in AD

Question 20

multiplier formula

Answer 20

k = 1/ (1-mpc)
MPC - marginal propensity to consume = change in consumption/change in income

Question 21

factors influencing high mutliplier value

Answer 21

• Economy has plenty of spare capacity
• Propensity to import and tax is low
• High propensity to consume any extra income

Question 22

factors influencing low multiplier value

Answer 22

• Economy is close to full capacity
• Rising demand causes inflation
• Higher inflation causes rising interest rates

Question 23

evaluation of multiplier

Answer 23

• Difficult to know exact size of multiplier - hard to measure
• time lag
• Economists disagree over its size
• LR multiplier effect is likely higher for developing economies than for developed ones; infrastructure projects often have higher multiplier effects.