Aggregate demand

Question 1

What does aggregate demand measure

Answer 1

Total spending on UK output

Question 2

What is the formula for aggregate demand

Answer 2

C+I+G+(X-M)

Question 3

How does changes in the GPL (measured by CPI) affect the AD curve

Answer 3

• Increase in GPL causes contraction along AD curve
• Fall in GPL causes expansion along AD curve

Question 4

What causes a shift in AD

Answer 4

Changes in any of the components of AD at a given price causing changes in output

Question 5

What is the most influential component of AD that leads to the largest change in GDP

Answer 5

Consumption

Question 6

How does an increase in household income impact consumption

Answer 6

• Increases willingness and able to spend, increases consumption
• Only looks at current income e.g. if income may fall in the future, consumption may stay the same

Question 7

How does a decrease in income tax or national insurance impact consumption

Answer 7

• Disposable income = income - (tax + national insurance) so increased disposable income increases consumption

Question 8

How do falling interest rates impact consumption

Answer 8

-Reduces incentive to save and increases incentive to borrow (talk about opportunity cost of saving)
- Increased borrowing causes increase consumption

Question 9

How does rising job security and household confidence impact consumption

Answer 9

Increased confidence about the future causes a decrease in precautionary saving, increases consumption

Question 10

What is the positive wealth effect and how does it impact consumption

Answer 10

Positive wealth effect is when value of assets increase, which increases consumer confidence as assets can be sold for a profit, which can be spent, increasing consumption

Question 11

How does easier credit availability from banks impact consumption

Answer 11

Easier to borrow money so more borrowing so more consumption
(opposite of a credit crunch)

Question 12

What is the relationship between risk and consumption

Answer 12

Consumption puts finances at risk so people are more likely to consume when their confidence is high

Question 13

What is the savings ratio

Answer 13

% of disposable income that is saved

Question 14

What factors affect the savings ratio

Answer 14

• Levels of wealth
• Interest rates
• Job security and confidence
• Willingness to accumulate debt

Question 15

What is investment

Answer 15

Spending on capital equipment by firms

Question 16

Why is investment the most volatile component of AD (can change from 25% to -25% very quickly)

Answer 16

• investment is a long term decision and the economic future is very uncertain
• Firms can delay investment projects (whereas they can’t delay paying wages)
  so investment is very flexible
• it is cheaper to invest if firms do it in bulk so they invest a lot or not at all, it doesn’t grow constantly

Question 17

What factors determine the level of investment

Answer 17

• Future economic growth
• Business profitability
• Levels of interest rates
• Government policy

Question 18

Explain why future economic growth impacts investment

Answer 18

• If economic growth occurs, demand increases and output from firms needs to match the demand
• If demand increases to full capacity, firms need to invest to increase full capacity to be able to meet demand
• This relationship is called the accelerator effect.

Question 19

Explain how business profitability impacts investment

Answer 19

An increase in business profits makes firms more willing and able to invest

Question 20

Explain how the level of interest rates impacts investment

Answer 20

• The investment will be less profitable if the costs of borrowing are higher
• Alternatively, firms may earn more interest on retained profits in a bank account, increasing profits

Question 21

How does government policy impact investment

Answer 21

• Taxes or subsidies impacts the net profit of firms, impacting willingness and ability to invest

Question 22

Why does a fall in exchange rates impact AD

Answer 22

Increases exports and decreases imports

Question 23

What is a fiscal policy

Answer 23

Type of government policy involving government spending and tax policies to influence AD

Question 24

What is a monetary policy

Answer 24

Type of government policy involving controlling availability of credit to impact AD

Question 25

What is the multiplier effect and what causes it

Answer 25

• When an initial injection/leakage into/out of the circular flow causes a greater final increase/decrease in national income
• caused because one agents spending is another agents income

Question 26

What is the formula for the multiplier effect

Answer 26

1/(1-Marginal Propensity to Consume)

Also

Final injection/ initial injection