5. aggregate demand

Question 1

What is aggregate demand?

Answer 1

It is the total demand for all final goods and services within the economy that households, firms, government, and foreigners want to purchase at a given price level.

Question 2

What are the 4 components of aggregate demand?

Answer 2

• Consumption demand: demand for goods and services by households in an economy
• Investment demand: private demand for spending on buildings, capital equipment, and changes to inventories
• Government demand: government demand for all final goods and services produced in the economy
• Net export demand: total demand for a country’s exports minus total demand for its imports.

Question 3

What is the formula for aggregate demand?

Answer 3

Aggregate demand= consumption demand+ investment demand+ government demand+ (exports demand - imports demand, AKA net exports demand )

Question 4

What is the AD curve?

Answer 4

a curve depicting total quantity of all types of demand in an economy at different possible price levels, where price level is the average prices of all goods and services in the economy.

Question 5

what does a change in price level cause, in the AD curve?

Answer 5

It causes a movement along the curve, can be upward or downward.

Question 6

what does a change in non-price factors cause, in the AD curve?

Answer 6

It causes a movement of the curve, can be a shift rightwards or leftwards.

Question 7

What is the first reason why aggregate demand curve has a downward slope?

Answer 7

The wealth effect. Price level impacts the purchasing power of people’s wealth, which causes a change in demand for goods and services. When price levels increases, real wealth decreases as their wealth is now able to buy less for the same amount of wealth, causing consumption demand to decrease.

Question 8

What is the second reason why aggregate demand curve has a downward slope?

Answer 8

Net exports effect. Changes in price level relative to the price level in other countries has a negative effect on the quantity of net export demand. When price levels increases, quantity of imports will be higher as domestic consumers find it cheaper to import than to purchase locally, and quantity of exports will be lower as foreign demand for local goods and services fall as exports become expensive.

Question 9

What can be inferred from the wealth effect and the net exports effect ?

Answer 9

There is a negative relationship between quantity of aggregate demand and price level, which results in a downward sloping aggregate demand curve.

Question 10

What are the non-price factors affecting aggregate demand, under consumption demand?

Answer 10

• disposable incomes (money after taxes)
• consumer confidence- degree of optimism
• household wealth- real and financial assets
• interest rates
• expectation of future inflation rates

Question 11

What are the non-price factors affecting aggregate demand, under investment demand?

Answer 11

• interest rates- affects return on investment
• business confidence- degree of optimism
• technological progress
• capacity utilisation
• taxation rates and subsidies provided by government- affects after-tax profits

Question 12

What are the non-price factors affecting aggregate demand, under government demand?

Answer 12

*autonomous expenditure- government spending that is independent of economic activity and is based on political decisions.

Question 13

What are the non-price factors affecting aggregate demand, under net export demand?

Answer 13

• tastes and preferences for an economy’s goods and services
• relative income of an economy and its trading partners
• fluctuations in currency exchange rates (affects both exports and imports)

Question 14

What would be the changes to AD in Malaysia, if Malaysia’s economy has grown compared to trade partners?

Answer 14

Income in Malaysia will increase, leading to increased imports, and hence lower net exports demand.

Question 15

What would be the changes to AD in Malaysia, if trade partners’ economy has grown compared to Malaysia’s?

Answer 15

Income in trade partner countries will increase, leading to increased Malaysian exports , and hence higher net exports demand.

Question 16

What would be the changes to AD in Malaysia, if the value of Malaysian Ringgit increased?

Answer 16

We Malaysians would have to pay less to acquire more foreign currency, so imports would be cheaper and hence demand for imports will increase. Moreover, foreigners in trade partner countries would have to pay more of their currency to acquire less Malaysian Ringgit, hence demand for Malaysian exports would decrease. Therefore, net exports demand would fall. Hence potentially causing Malaysian AD to fall as well.