aggregate demand

Question 1

what is AD

Answer 1

Aggregate Demand is defined as the total planned expenditure on goods and services produced in an economy.

Question 2

components of AD

Answer 2

Consumption (C) 65%
Investment (I) 18%
Government spending (G) 21%
Exports (X) 29%
Imports (M) – 33%

Question 3

why AD curve slopes downward 1

Answer 3

The AD curve is downward sloping because:

Exports and Imports: Lower prices in an economy increase global competitiveness, so exports increase and imports decrease. Therefore, net exports are higher at lower prices, so AD increases.

Question 4

why AD sloped downward 2

Answer 4

Interest Rates: At higher price levels, interest rates are likely to be raised by the monetary authorities (to tackle inflation). Higher interest rates increases the cost of borrowing and increase the mortgage interest repayments, so investment will fall and savings increase (so consumption falls). Hence, AD decreases.

Question 5

What are the main influences on consumer spending?

Answer 5

interest rates
house prices
consumer confidence

Question 6

interest rates how?

Answer 6

Higher interest rates increase the cost of borrowing, and increase the benefit of saving. Therefore people borrow less and save more-­‐ consumption falls.
Higher interest rates increase the cost of mortgages (higher mortgage interest repayments), reducing the amount of money consumers have to spend on goods and services.

Question 7

house prices how?

Answer 7

If house prices increase, consumers could go to their mortgage provider and request more mortgage equity release (i.e. take out a loan based on the increased wealth). This adds to the consumer’s disposable income, so consumption therefore increases.
If house prices increase, consumers feel more confident and ‘wealthier’, and therefore save less and spend more.

Question 8

consumer confidence how?

Answer 8

If consumers are confident, both in terms of job security and future income prospects, they will tend to spend more and also make large purchases which they can pay for in the future.

Question 9

what is investment

Answer 9

Investment refers to expenditure by firms on capital stock.

Question 10

What are the main influences on investment by firms?

Answer 10

Influences of Government Regulation and Incentives
Confidence Levels
Interest Rates

Question 11

interest rates how??

Answer 11

To invest in capital stock, firms have to borrow money to finance the investments. Higher interest rates increase the cost of borrowing, and hence makes investment less attractive for firms.

Question 12

evaluative point for investment

Answer 12

Evaluative Point: However, many argue that interest elasticity of demand for investment is very low because investors are sometimes driven more by other factors, such as confidence in future sales patterns, actions of competitors, government incentives +regulations and the prospects for future interest rates. Moreover, not all investment has to be funded from borrowing-­‐ some can be funded by past profits.

Question 13

consumer confidence how??

Answer 13

If firms are confident about future sales, they will invest and try and improve their productive capacity so that they can increase supply in the future.
Inflation creates uncertainty around future demand, and therefore discourages investment.
If sales have recently been very good, future prospects look good so firms will tend to invest.
However, if sales are slow, firms might also improve in certain capital resources to try and improve quality of products to boost sales.

Question 14

Influences of Government Regulation and Incentives how??

Answer 14

If taxes fall, then firms will be more confident about future revenue and will therefore invest more.
If the government gives a firm a subsidy to produce more of a certain product, then they will invest in capital stock so that they can produce more.

Question 15

what is government spending

Answer 15

Government Spending refers to expenditure by local and central government.

Question 16

main influences on government spending?

Answer 16

Unemployment Levels
Fiscal position (see demand-side policies)

Question 17

What are exports and imports?

Answer 17

Exports are goods and services purchased from the economy by foreigners
Imports are goods and services purchased by residents from abroad

Question 18

what can effect exports/imports

Answer 18

A change in the exchange rate

Question 19

impact of higher exchange rate

Answer 19

A high exchange rate makes increases the value of the econony’s currency, making exports more expensive to foreigners and imports cheaper to residents. Therefore, imports increase and exports fall, so AD falls.

Question 20

evaluative point for x-m

Answer 20

The change in the exchange rate might have the opposite effects in the long and short run. In the short run, the PED for exports and imports tends to be low. This is because contracts for international trade deals are signed in advance. For example, a British importer of cars will agree a price for the delivery of 200 cars well in advance of delivery from Germany. If the pound gets stronger in the meanwhile, the original price will still be used, despite the cars now being cheaper for the British importer. Hence, in the short run there is little change to AD. However, if the pound continues to appreciate, the German exporter might look to sell elsewhere, and this would have an effect on AD in the long run. Also, PED tends to be low because many imports are goods with few substitutes, such as oil.

Question 21

how can changes in the world economy affect x-m

Answer 21

If there was a recession in the US, the UK economy would sell fewer exports to the US.

A boom in the stock market in the US would lead to more UK exports to the US due to wealth effects.

If inflation in the UK is high relative to the rest of the world, then net exports would decrease for the UK. If inflation is low relative to the rest of the world, then net exports would increase for the UK. Therefore, we can see that the global economy is a key determinant to the net exports of the UK.

Question 22

how can Non-­‐Price Factors affect x-m

Answer 22

non-­‐price factors, such as quality and customer service, also affect net exports. For example, Germany cannot compete effectively on price, but it is the largest exporters of goods due to its high quality of design and manufacture.