2.3/2.4 Aggregate Demand And The Level Of Economic Activity

Question 1

Aggregate demand definition

Answer 1

The total planned spending on real output produced within the economy

Question 2

Aggregate demand equation

Answer 2

C + I + G + (X-M)

Question 3

Why is aggregate demand and aggregate supply more useful than circular flow of income model?

Answer 3

It’s possible to see the potential inflationary and deflationary impact of changes in government policy, as well as the effect on national income

Question 4

Why does the aggregate demand curve downward slope from left to right?

Answer 4

• At a lower price level any asset of shares will increase in real terms. Leading to wealth effect and greater consumption.
• at a lower price level UK exports will be more price competitive leading to higher exports

Question 5

Wealth effect definition

Answer 5

Increase in the value of the household assets cause people to fill wealthier and encourage them to spend more of their current income

Question 6

Wealth definition

Answer 6

The value of the assets held by households

Question 7

How much power does consumption have in the AD curve?

Answer 7

It holds 70% of overall AD

Question 8

What will cause a shift in AD?

Answer 8

Any change in the components of aggregate demand equation

Question 9

Interest rate definition

Answer 9

The cost of borrowing money expressed as a percentage of the amount borrowed

Question 10

What are the five things that cause consumption to change?

Answer 10

• interest rates
• consumer confidence
• taxation
• wealth
• unemployment

Question 11

How do interest rates affect consumption?

Answer 11

• if interest rates rise people with variable-rate mortgages will find that their monthly payments increase = less disposable income = less C
• higher interest rate reduces the desire for households to engage in credit financed consumption (borrowing)
• High interest rates increase the reward for saving which reduces consumption

Question 12

How does taxation affect consumption?

Answer 12

Changes in taxation will affect how much households have to spend = how much they consume

Question 13

How does wealth affect consumption?

Answer 13

If households feel wealthier, the wealth effect will occur which equals more consumption

Question 14

How does unemployment effect consumption?

Answer 14

If more people are unemployed and relying on welfare benefits, then the level of consumption is likely to be lower

Question 15

What are the five things that affect investment?

Answer 15

• interest rates
• business confidence
• tax
• technology
• accelerator theory

Question 16

How does interest rates affect investment?

Answer 16

• Increasing interest rates will raise the cost of borrowing and will reduce the profitability of any investment
• even if investment is not finance by borrowing higher interest rates will raise opportunity cost of using money from investment purposes

Question 17

How does business confidence affect investment?

Answer 17

If businesses expect the sales to increase in the future they will be more likely to invest, vice versa

Question 18

How does tax effect investment?

Answer 18

Companies are taxed on their profits, corporation tax, if this is lowered this will lead to higher investment

Question 19

How does technology affect investment?

Answer 19

Newer and more efficient technology leads to more investment, leading to an increase in firms profitability due to higher rates of efficiency

Question 20

How does the accelerator theory affect investment?

Answer 20

If growth in national income increases, then firms will need a larger productive capacity in order to produce a higher level of output to meet the higher level of spending in the economy which means they must invest

Question 21

Accelerator theory definition

Answer 21

Where increases in national income lead to firms spending more on investment, in order to expand their capacity to exploit the rising income

Question 22

Capital stock definition

Answer 22

The value of the existing level of investment products in an economy at a point in time

Question 23

Budget balance definition

Answer 23

The difference between government spending and the taxation revenue collected The difference between government spending and the taxation revenue collected

Question 24

Balanced budget definition

Answer 24

Government expenditure is equal to taxation

Question 25

What affects exports and imports?

Answer 25

• exchange rates
• uk growth
• relative inflation

Question 26

Exchange rate definition

Answer 26

The price of one currency expressed in terms of another currency

Question 27

Multiplier affect definition

Answer 27

Initial injection into the economy causes a bigger final increase in national income

Question 28

How does the multiplier affect work?

Answer 28

Any extra spending, injections, creates income for another person or business. This extra income will intern be spent again, that’s creating income elsewhere for another group, and so on.

Question 29

Size of multiplier equation

Answer 29

Change in national income
————————————
Initial change in AD

Question 30

What is a negative multiplier effect

Answer 30

If the government cut spending, this can lead to a spiral of negative outcomes eg. Loss of jobs, etc

Question 31

Marginal prosperity to consume definition

Answer 31

Refers to the proportion of any additional income that is spent and passed on around the circular flow of income

Question 32

What will MPC be between?

Answer 32

0 and 1
1 = all additional income is spent
0.5 = half of all additional income is spent
0 = no additional income is spent

Question 33

Size of multiplier equation using MPC

Answer 33

1
—————
1 - MPC

Question 34

Size of multiplier using marginal propensity to withdraw

Answer 34

1 1
——— = ————————
MPW MPS+MPT+MPM

Marginal prosperity to save
Marginal prosperity to tax
Marginal prosperity to import

Question 35

What is crowding out?

Answer 35

• monetarists argue the fiscal multiplier will be limited with the crowding out effect
• if the gov increase AD by more spending or less tax this increases consumption
• however rise is borrowing leaded to a decline in private sector investment
• therefore there is no overall increase in AD

Question 36

What is the Keynesian view on crowding out?

Answer 36

• in a recession, Keynesians argue that the private sector typically had a glut of non-productive savings, therefore the crowding out affect is limited and there will be a positive multiplier affect