AD/AS analysis (components of AD and influencing factors)

Question 1

Define aggregate demand

Answer 1

total demand for final goods and services in an economy at a given time made up of Consumer Expenditure + Investment + Government Spending + Foreign trade sector (Xports-Mports)

Question 2

Define aggregate supply

Answer 2

total planned output for the economy at a given price level (change in cost or quality of factors of production)

Question 3

What influences Consumer expenditure, C

Answer 3

Income and Consumption:
Wealth effects: any asset that has exchange value, stock concept, houses, pensions, interest repayments
Consumer confidence: job security, surveys
Interest rates: when increasing people spend less as more beneficial to save and less is bought
Availability of Credit: borrow more and spend more if more available

Disposable income influences consumer spending
More savings means less consumption

Question 4

What influences Investment, I

Answer 4

Investment = additions to capital stock of the economy
Gross investment – depreciation = net investment

Demand for exports - exports, injection into circular flow, more growth, more profit, more money for investment
Cost of capital – investment rate decreases as this increases as rate of interest – gross rate of return = net rate of return
Technological change – improve productivity of equipment
Expectations – ‘Keynes: the animal spirit’ people will invest more as confidence increases
The rate of economic growth – the accelerator theory: economic growth results in larger rise in investment
Profits – most investments funded by reinvested profits
Interest rates and availability of credit – more people borrow money as it costs less
Cost of capital decreases, production costs decrease, investment increases, demand increases
Business confidence decreases, investment decreases, demand decrease
Reduce regulations and government influences can promote investment

Question 5

What factors influence Government expenditure, G

Answer 5

The trade cycle
Taxation
Ageing population, pensions, benefits, national defence costs
inflation rates
Fiscal policy 
Budget deficit/surplus

Question 6

What factors influence Foreign Trade Sector

Answer 6

Net exports
Exchange rates: Strong Pound Imports Cheap Exports Dear, exchange rate up price of exports up, export sales down, BoT worsens however if exports inelastic PED<1 then total profit increases so BoT doesn’t worsen

J curve – short run FTS PED<1 long run x+m >1

UK real income and global economic climate – protectionism (barrier preventing flow of imports)

Inflation rate — competitiveness in EU due to confidence and rising prices

Real income
Exchange rate
State of world economy
Protectionism

Question 7

What components of AD are most significant (evaluation)

Answer 7

C, G, I, FTS

Question 8

Why does AD slope down

Answer 8

AD slopes downwards due to exchange rate – price of goods goes up exports down AD down
And wealth effect – lower prices, assets worth more, consumptions increase, AD increase
Interest rates - Prices up, hold more money, demand for borrowing increases, interest rates rise, consumption, AD and investment decreases

Question 9

Factors affecting ShortRunAS

Answer 9

Increasing wage rates (F.O.P decrease as production costs increase so supply decrease)
Changes in costs of raw materials and energy - Falling raw material prices (firms buy more so supply increases)
Changes in exchange rates - Increasing value of the pound (exports down imports up supply up)
Changes in tax rates - Increasing tax levels (tax up production costs up AS up)

When there is a large change in wage rates, raw materials (such as oil price collapse) or taxation a supply-side shock is said to have occurred

Oil prices down (lead to a decrease in input prices and thus decrease costs of production across the economy causing a positive increase in AS leading to a decrease in general price level, capacity of economy rises and real national income rises)

Question 10

Factors affecting LRAS

Answer 10

Land (adjust uses and improve quality)
Capital (low interest rates, invest n infrastructure)
Enterprise (lower tax rate, economic stability)
Labour (invest in health services improving birth and death rates, encourage immigration, invest in education)

Technological advances
Changes in relative productivity 
Changes in education and skills
Changes in government regulations
Changes in migration
Competition policiy

Question 11

Macro axis’

Answer 11

P and Y

Question 12

Examples of government spending

Answer 12

Current government expenditure - teacher and NHS wages, energy, school books

Capital government expenditure - school tables and chairs, hospital machines

Transfer payments (no good or service is received in return of payment) - benefits, state pension

Question 13

What other factors influence government spending

Answer 13

ageing population
increased life expectancy
more healthcare, pensions and benefits

Question 14

Marginal propensity to import =

Answer 14

change in total imports
/
change in total income

Question 15

What is protectionism, how might it influence UK net exports

Answer 15

any barrier that is erected to prevent the flow of foreign imports into your country e.g. via tariffs
This causes a decrease in imports meaning that net exports increases (exports - imports) causing an increase in aggregate demand

Question 16

Explain each stage of the trade cycle (time against GDP growth)

Answer 16

Boom (fast economic growth - could be inflationary or unsustainable) receive more tax revenue as more consumer spending so more VAT and more income tax paid and less spending by government as economy does not need stimulating and less benefits claimed

Recession (negative economic growth increase spending to stimulate economy by spending on welfare payments to help people who have lost their jobs, or by cutting taxes. Also there are more benefits claimed as less incentive to work

Slump - government spending increases overall because of things like benefits

Recovery - real output increases when there are periods of economic growth

Question 17

What are the characteristics of a boom

Answer 17

High rates of economic growth

Near full capacity or positive output gaps

Near full employment

Demand pull inflation

High consumer and business confidence so more consumption and investment

Improve government budgets due to higher tax revenues and less welfare payment spending

Question 18

What are the characteristics of a recession

Answer 18

Negative economic growth over two quarters

lots of spare capacity and negative output gaps

Demand deficient unemployment

Low inflation rates

Government budget worsen due to more spending on welfare payments and lower tax revenues

Less business and consumer confidence so less consumption and investment

Question 19

Classical short run
Classical long run
Keynesian short run
Keynesian long run

Answer 19

• normal
• perfectly inelastic supply so straight vertical line showing full employment as classical economists believe all markets will clear eventually whereas Keynesian economists say there will always be unemployment due to redundancies and people moving jobs and structural unemployment etc…

Keynesian curves are short and long run at same time so are very elastic in short run then curves to very inelastic in long run, when it is completely vertical so perfectly inelastic it has reached full employment. At Y1 below full employment there is a negative output gap.