4.2.2.3_-_The_determinants_of_aggregate_demand

Question 1

What is aggregate demand?

Answer 1

Aggregate demand is the total demand in the economy. It measures spending on goods and services by consumers, firms, the government and overseas consumers and firms

Question 2

What is the equation for AD?

Answer 2

C + I + G +(X-M)

Question 3

What is consumer spending?

Answer 3

This is how much consumers spend on goods and services. This is the largest component of AD and is therefore most significant to economic growth. It makes up just over 60% of GDP

Question 4

What is real income?

Answer 4

the income of an individual or group after taking into consideration the effects of inflation on purchasing power

Question 5

What is disposable income?

Answer 5

Disposable income is personal income that remains after direct taxes and government charges have been paid

Consumer income might come from wages, savings, pensions, benefits and investments, such as dividend payments.

Savings are made instead of consumption so income can either be saved or consumed

Question 6

What is a consumers marginal propensity to consume (mpc)?

Answer 6

How much a consumer changes their spending following a change in income

Question 7

What is a consumers marginal propensity to save (mps)?

Answer 7

The proportion of each additional pound of household income that is used for saving

A consumer’s marginal propensity to consume added to the marginal propensity to save is equal to 1

Question 8

What are the main influences on consumer spending

Answer 8

• Interest rates
• Income levels
• Consumer confidence
• Wealth effects
• Taxes
• Level of unemployment

Question 9

What is capital investment?

Answer 9

Money spent by firms on assets which they will use to produce goods/services e.g. capital machinery, computers and offices. It accounts for around 15% of AD in the UK

Question 10

What is the difference between savings and investment?

Answer 10

Savings tend to be made by households, whereas investments tend to be made by firms.

Question 11

What are the main influences on investment made by firms?

Answer 11

• Level of risk
• Government incentives and regulation
• Interest rates and access to credit
• Technical advances
• Business confidence / animal spirits
• Market demand

Question 12

What is meant by animal spirits in terms of business confidence?

Answer 12

Business confidence depends partly on general optimism or pessimism of the company’s managers.
Not all investment decisions are based purely on reason and rational thinking, human emotion, intuition and ‘gut instinct’ are also important factors. Keynes recognised this and called these factors ‘animal spirts’

Question 13

What is meant by the accelerator effect?

Answer 13

The accelerator effect suggests that the level of investment in an economy is related to the change in GDP. A higher rate of economic growth causes more investment.

The level of investment is more volatile than the rate of economic growth.

Firms will make an ‘accelerated’ investment in capital goods, expecting to increase output and make profit in the future

Question 14

When is the accelerator effect likely to occur?

Answer 14

When the economy is going through recovery or at the start of a boom. These are times when demand will be rapidly increasing and firms will need to invest to meet this demand.

Question 15

What is government spending?

Answer 15

How much the government spends on state goods and services, such as schools and the NHS.

Only money that directly contributes to the output of the economy is included. This means that transfers of money such as benefits or pensions are not included

Question 16

Why might government spending not be equal to revenue?

Answer 16

Expansionary fiscal polices cause governments to overspend in times of economic decline to boost AD and economic growth.

Contractionary fiscal polices cause governments will spend less when the economy is experiencing booms to try and reduce AD and slow economic growth

Question 17

What do governments use fiscal policies for?

Answer 17

To alter their spending and taxation to influence aggregate demand

Question 18

What is a government budget?

Answer 18

A government budget outlines a government’s planned spending and revenue for the next year. Governments will either have a surplus or deficit on their budget

Question 19

What are the main influences on government spending?

Answer 19

• The business/trade cycle
• Fiscal policy

Question 20

What is the business/trade cycle?

Answer 20

Refers to the stage of economic growth that the economy is in. The economy goes through periods of booms and busts

Question 21

Is fiscal policy a demand or supply side policy?

Answer 21

A demand-side policy, so it works by influencing the level or composition of AD

Question 22

What is Discretionary fiscal policy?

Answer 22

A policy which is implemented through one-off policy changes

Question 23

What are Automatic stabilisers?

Answer 23

Policies which offset fluctuations in the economy. These include transfer payments and taxes. They are triggered without government intervention

Question 24

What is net exports?

Answer 24

Exports - Imports. This is the value of the current account on the balance of payments. A positive value indicates a surplus, whilst a negative value indicates a deficit. The UK has a relatively large trade deficit, which reduces the value of AD. This is the second largest component of AD

Question 25

What are the main influences on net exports?

Answer 25

• Exchange rates
• Changes in the state of the world economy
• Degree of protectionism
• Real income
• Non-Price factors (quality of goods, operating in a niche market, competitiveness, trading blocs/trade deals)

Question 26

What is protectionism?

Answer 26

The act of guarding a country’s industries from foreign competition. It can take the form of tariffs, quotas, regulation.
If the UK employed several protectionist measures, then the trade deficit will reduce.
Since protectionism leads to retaliation, exports might decrease too, which undoes the effect of reduced imports.

Question 27

Explain an example of how the multiplier and accelerator work together

Answer 27

• During a recovery AD will be growing
  This leads to firms increasing their levels of investment - - Which leads to another increase in AD.
• This increase in AD is then ‘multiplied’, making growth in national income more rapid
• Which leads to even more ‘accelerated’ investment

Question 28

How can the accelerator process and multiplier effect both happen in reverse?

Answer 28

During a recession, there is likely to be a fall in demand and a fall in investment, which will then have a reverse multiplier effect.
This can lead to a constant cycle of output first rising then falling
The explanation of the economic cycle is called the multiplier-accelerator model