2.3 - AD

Question 1

What is the real balance effect?

Answer 1

When the price level rises, the purchasing power of consumers falls, so AD falls

Question 2

What is the interest rate effect?

Answer 2

When interest rates rise, borrowing becomes more expensive due to higher repayments. Consumers borrow less so they spend less and save more, and reduce AD.

When interest rates rise, borrowing becomes expensive so firms borrow less to invest, and therefore investment falls, decreasing AD.

Question 3

What is the international trade effect ?

Answer 3

When the price level increases, this reduces the competitiveness of exports, so net exports falls, and AD falls.

Question 4

What is gross investment and what is net investment?

Answer 4

Gross investment is an increase in the capital stock. It is the sum of net investment and depreciation.

Net investment is the new addictions to the capital stock after taking into account the fall in value of the capital stock. It is gross investment - depreciation