6) Aggregate Demand

Question 1

What does AD mean

Answer 1

⚫️sum of spending
➡️in goods and services
➡️in an economy
➡️over a period of time

⚫️AD=(C)+(I)+(G)+(x-m)

Question 2

What does consumption mean

Answer 2

⚫️total spending
➡️of UK households
➡️on goods and services
➡️for their own private use

Question 3

What are the factors which may cause consumption to increase

Answer 3

⚫️interest rates decreases

⚫️income tax decreases

⚫️savings ratio decreases

⚫️unemployment decreases
➡️increasing consumers confidence

⚫️real income increase

⚫️positive wealth effect
➡️rising asset price
➡️individual feel more wealthy
➡️so consume more

Question 4

What are the two evaluation of consumption as a component of AD

Answer 4

⚫️largest component of AD
➡️2/3rd of AD in the UK

⚫️main reason for economic growth
➡️in the UK
➡️between 1997 to 2007
➡️due to positive wealth effect

⚫️rising house prices
➡️encouraged individuals to take out loans
➡️based on the increased value of their property

Question 5

What does savings mean

Answer 5

⚫️the proportion of income not spent on
➡️consumption
➡️imports
➡️taken in taxation

Question 6

Why do people save?

Answer 6

⚫️precautionary reasons

⚫️building up potential spending power

⚫️interest rates

⚫️life-cycle reasons

Question 7

Why do people save because of precautionary reasons

Answer 7

⚫️fear of being redundant

➡️important during recession time

Question 8

Why do people save to build up potential spending power

Answer 8

⚫️to finance major spending commitment
➡️in the future
➡️car, wedding

Question 9

Why do people save because of interest rates

Answer 9

⚫️greater incentives to save
➡️because of high interest rates from

➡️banks
➡️building societies
➡️other financial institutions

Question 10

Why do people save for life-cycle reasons

Answer 10

⚫️younger people need money to
➡️fund their university education
➡️purchase a property
➡️expensive consumer goods

⚫️as people grow older
➡️income rise
➡️spending commitment decline 
➡️as children leave home
➡️leading to increase in saving 
➡️for retirement

Question 11

What does household saving ratio mean

Answer 11

⚫️level of households savings
➡️as a percentage of
➡️household disposable income

Question 12

What happens to the saving ratio during recession

Answer 12

⚫️increases

➡️due to fear of unemployment

Question 13

What happens to the saving ratio during boom

Answer 13

⚫️decrease
➡️due to increase in
➡️consumer confidence
➡️spending

Question 14

What does investment mean

Answer 14

⚫️spending on capital goods
➡️by businesses
➡️factories and machinery
➡️creates future production capacity

Question 15

What are the factors which causes investment to increase

Answer 15

⚫️interest rates decreases

⚫️corporation tax decrease

⚫️consumer demand increases

⚫️business confidence increase
➡️about future consumer demands

Question 16

What are the two evaluation of investment

Answer 16

⚫️Even-though investment 
➡️only 20% of AD
➡️fluctuates a lot 
➡️depending on businesses confidence 
➡️on future sales

⚫️short run
➡️AD increases
➡️impacts on Real GDP

⚫️long run
➡️more lasting impact
➡️expands future productive capacity
➡️AS and PPF shifts to the right

Question 17

What does the accelerator effect mean

Answer 17

⚫️proportionately bigger effect on investment

➡️likely to be caused by a change in AD

Question 18

Describe the accelerator effect when the economy is growing quickly and consumer demand is high

Answer 18

⚫️investment increases
➡️due to firms 
➡️being confident about the future 
➡️so they purchase capital goods 
➡️to meet expected future demands
➡️shifts AD right 
➡️increase in investment
➡️increase in productive capacity

Question 19

What is the effect of the accelerator when the economy is slowing down

Answer 19

⚫️reduces consumer demand
➡️excess capacity
➡️lead to decrease in investment

Question 20

What does government spending mean

Answer 20

⚫️spending by
➡️government departments and local councils
➡️on goods and services
➡️like schools and hospitals

Question 21

What does government spending not include and why

Answer 21

⚫️Benefits payments
➡️such as JSA and pensions
➡️they’re transfer payments to consumers
➡️counted as consumption

Question 22

What are the factors which may cause government spending

Answer 22

⚫️objectives of the government in power
➡️e.g labour party 
➡️spend more overall 
➡️than conservative party 
➡️when its in power

⚫️current economic situation
➡️e.g the current government
➡️reducing 
➡️government debt
➡️and budget deficit 
➡️therefore government spending is being cut overall

Question 23

What is the 3 evaluation of government spending

Answer 23

✅ creates long term benefits
➡️by improving quality of factors of production
➡️e.g spending on education and health care

❎if government spend too much
➡️raises taxes

❎spending plan 
➡️only changes 
➡️once a year in the budget
➡️must be approved 
➡️by a vote of all MPs in the parliament

Question 24

What does net exports mean

Answer 24

➡️the value of exports minus the value of imports

Question 25

Describe the net exports

Answer 25

⚫️exports
➡️injection to circular flow
➡️foreigners spending on
➡️UK goods and services

⚫️imports
➡️leakage from circular flow
➡spending by UK people
➡️on overseas economies

Question 26

Why might exports increase

Answer 26

⚫️depreciate in the value of £
➡️making our goods and services
➡️cheaper overseas

⚫️increase in the UK productivity
➡️reducing business cost

⚫️growth in consumer demand
➡️in overseas markets

Question 27

Why might imports increase

Answer 27

⚫️increase in uk consumer demand

⚫️high level of UK inflation
➡️making imports from other countries
➡️look cheaper

⚫️increase in the value of pound
➡️making imports look cheaper

Question 27

What is the evaluation of net exports

Answer 27

⚫️uk is a very open economy
➡️buying in a lot of imports
➡️and selling a lot of exports
➡️therefore trade is very important for our economy

⚫️UK runs a large trade deficit
➡️so (x-m)
➡️is negative in AD in the UK