aggregate demand

Question 1

what is aggregate demand

Answer 1

Aggregate demand (AD) is the total demand for all goods and services in an economy at any given average price level

Question 2

what is the AD equation?

Answer 2

AD = Consumption (C) + Investment (I) + Government spending (G) + (Exports-Imports) (X-M)

Question 3

explain each of the components?

Answer 3

Consumption is the total spending on goods and services by consumers (households) in an economy

Investment is the total spending on capital goods by firms

Government spending is the total spending by the government in the economy
Includes public sector salaries, payments for provision of merit and public goods etc.
It does not include transfer payments

Net exports are the difference between the revenue gained from selling goods or services abroad and the expenditure on goods or services from abroad
Individuals, firms and governments export and import

Question 4

what is relationship between the average price level and the total output in an economy shown?

Answer 4

shown with an aggregate demand (AD) curve

Question 5

what causes a movement along the AD curve?

Answer 5

a change in the average price level which can cause an expansion or contraction

Question 6

what happens when there is an increase in average price?

Answer 6

An increase in the AP (ceteris paribus) from AP1 → AP2 leads to a movement along the AD curve from A → B
There is a contraction of real GDP from Y1 → Y2

Question 7

draw the AD diagram

Question 8

what happens when there is a decrease in average price?

Answer 8

A decrease in the AP (ceteris paribus) from AP1 → AP3 leads to a movement along the AD curve from A → C
There is an expansion of real GDP (output) from Y1 → Y3

Question 9

what factors can cause the entire ad curve to shift

Answer 9

Whenever there is a change in any of the factors of aggregate demand (AD) in an economy, there is a shift of the entire AD curve

Question 10

draw shift in ad diagram
Diagram analysis

Answer 10

An increase in any one of the determinants of aggregate demand (AD) results in a shift right of the entire curve from AD1 → AD2
At every price level, real GDP has increased from Y1 → Y2

A decrease in any one of the determinants of AD results in a shift left of the entire curve from AD1 → AD3
At every price level, real GDP has decreased from Y1 → Y3

Question 11

what factors can affect consumption?

Answer 11

change in consumer confidence
changes in interest rate
changes in wealth

Question 12

what factors can affect investment?

Answer 12

changes in business confidence
changes in gov intervention
changes in interest rates

Question 13

what factors can affect government spending?

Answer 13

capital spending
political decisions
trade cycle

Question 14

what factors can affect exports ?

Answer 14

changes in incomes from broad
changes in level of inflation
changes in exchange rates

Question 15

what factors can affect imports?

Answer 15

changes in domestic income
changes in exchange rates
changes in levels of inflation

Question 16

what is consumption?

Answer 16

Consumption is the total spending on goods and services by consumers (households) in an economy

Question 17

factors that can cause a change in the level of consumption

Answer 17

changes in interest rates - nterest rates are set by the government’s Central Bank
Changes to the base rate cause commercial banks to change the lending and saving rates they offer customers

A change in interest rates will change the level of consumer spending and savings
If interest rates increase there is a greater incentive to save
More saving = less consumption
If interest rates increase, the monthly repayment on any loan or mortgage increases
Higher loan repayments = less consumption

changes in consumer confidence - The stronger the economy, the higher consumer confidence
Consumers feel secure in their jobs and are confident of receiving regular salary payments
Consumption increases and saving decreases

In a weakening or recessionary economy, consumer confidence falls
Consumers feel less secure in their jobs
Consumption decreases and saving increases

changes in wealth - If consumer wealth increases, then consumption usually increases
Rising property prices or share prices give consumers confidence to borrow more money
Increased borrowing = increased consumption

The level of disposable income - Consumption increases as disposable income increases
Consumption decreases as disposable income decreases

Question 18

what is investments ?

Answer 18

Investment is the total spending on capital goods by firms

Question 19

what can investment help to increase?

Answer 19

Investment helps to increase the capacity (production possibilities) of an economy
Increased capacity = increased potential economic growth

Question 20

what are the factors that cause a change in a level of investment

Answer 20

business confidence - The longer the period of economic growth, the higher the business confidence will be
If growth slows, future expectations of profits will decrease, and investment decisions will become harder

changes in government intervention - Government intervention can increase investment e.g. subsidies
Government regulation can decrease investment (it raises costs of production for firms and can lower profits)

changes in interest rates - Most investment by firms is financed through business loans
Decreasing interest rates encourage investment
There is a mostly inverse relationship between investment and interest rates

Demand for exports - If demand for exports increases, firms will likely invest to meet the global demand
Demand for exports can increase if the exchange rate depreciates as goods/services now seem cheaper to foreigners

Question 21

what is government spending influenced by ?

Answer 21

The level of government spending is influenced by the economic cycle, the political agenda, and the planned level of capital spending

Question 22

why is net trade balance?

Answer 22

The net trade balance is the difference between the value of the exports and imports (X-M)
The net trade balance is influenced by changes to real income, exchange rates, and the degree of protectionism

Question 23

what are the factors that influence government?

Answer 23

economic cycle - Governments will spend more in a recession to stimulate the economy and less during times of inflation
Unemployment decreases with a booming economy, leading to a lower level of means-tested benefit payments, and vice versa
Tax revenue increases with a booming economy and can be used to pay back government debt or increase expenditure on public/merit goods - and vice versa

Political decisions - Political decisions made to gain popularity often involve increasing spending to secure votes

Capital spending - National capital investments such as building roads and railways
Government expenditure can happen on a local level (e.g., Kent County Council) or a national level (central government)

Question 24

what are the factors impacting exports and imports

Answer 24

export levels - The higher the incomes abroad, the higher the demand for exports
If inflation rate of UK is lower relative to trading partners, the higher the demand for UK exports
If UK sterling depreciates in value, exports are less expensive for foreigners; exports increase
An increase in protectionism (regulation, tariffs) would lead to retaliation from other countries and demand for exports would fall

Import levels - Level of income of UK residents increases, demand for imports increases
If inflation rate of UK is lower relative to trading partners, the lower the demand for UK imports
If sterling appreciates in value, then consumers’ income goes further abroad and demand for imports increases
An increase in protectionism (regulation, tariffs), would lead to decreased demand for imports as they are more expensive