3 - Aggregate Demand

Question 1

What is aggregate demand?

Answer 1

Total amount of spending on goods and services produced in an economy during a period of time

Question 2

What is aggregate supply?

Answer 2

Total planned output of goods and services in an economy at a given point in time

Question 3

What is determined when Aggregate Demand and Aggregate Supply meet?

Answer 3

Average price level (inflation)

Real output level

Question 4

What is the equation for aggregate demand?

Answer 4

AD= Consumption + Investment + Government Spending + (Exports - Imports)

Question 5

What is the aggregate demand curve?

Answer 5

Shows relationship between aggregate demand and overall price level
Slopes downwards from left to right
Inverse relationship between aggregate demand and general price level

Question 6

What is the wealth effect?

Answer 6

A lower average price level will result in a greater amount of goods and services that wealth can buy.

Question 7

What is the interest rate effect?

Answer 7

When price level is low, interest rates tend to be low (less demand for money). This encourages a higher level of consumption and investment.

Question 8

What is the international trade effect?

Answer 8

A lower domestic general price leads to domestically produced goods being more price competitive
Consumers and firms are less likely to import from abroad
Net exports are higher at lower price levels

Question 9

What does movement along the AD curve show?

Answer 9

Change in price level
Increase in price level shows inflation
Decrease shows deflation

Question 10

What determines consumption?

Answer 10

Change in consumer confidence - How optimistic about their future income

Change in interest rates - Makes borrowing more expensive so less consumer spending

Changes in wealth - Increase makes people feel wealthier so they spend more

Changes in level of household indebtedness - High level of debt means pressure to make monthly payments so less likely to spend

Question 11

What is a capital and consumer good?

Answer 11

Capital - Produces goods and services (machinery)

Consumer - Satisfy consumer needs

Question 12

What is investment?

Answer 12

Addition to the capital stock of economy factories

Spending on capital goods

Question 13

What is gross and net investment?

Answer 13

Gross - Total amount of spending on capital goods without taking depreciation into account

Net - Gross investment - depreciation

Question 14

What is depreciation?

Answer 14

Gradual decrease in the economic value of capital stock through either physical depreciation, insolence or changes in demand

Question 15

What is physical and human capital?

Answer 15

Physical - Factories, machinery

Human - Education, training

Question 16

How does interest rate affect investment?

Answer 16

Higher interest means lower profit as firms borrow money to start

Makes less investment projects profitable

For retained profit (savings that firms keep), higher interest is better

Question 17

What are the determinants investment?

Answer 17

Changes in business confidence 
Changes in interest rates
Changes in technology
Changes in business tax
Level of corporate indebtedness
Legal changes

Question 18

What is government spending?

Answer 18

Expenditure by government in education, healthcare and public services

Affects state pension, unemployment benefits, creates jobs and affects government subsidies

Question 19

What factors affect government spending?

Answer 19

Changes in political priorities

Changes in economic priorities - Influence aggregate demand

Question 20

How Is government spending affected by the economic cycle?

Answer 20

Rising GDP - More tax revenue (income, corporation, VAT)

Less spending (less unemployment benefits, low crime, some people may switch to private services)

Question 21

What factors affect net trade?

Answer 21

Changes in national income abroad - Increase in Country B national income so import of more goods and services from country A

Change in exchange rates

Change in the level of trade protection - No trade restrictions by country A but restrictions on imports by country B means country A exports fall, less AD