Aggregate Demand

Question 1

What are the five components of AD?

Answer 1

Consumption, investment, government spending, exports-imports

C+I+G+(x-m)

Question 2

What is consumption?

Answer 2

The purchase of goods and services by households

Question 3

What are the determinants of consumption?

Answer 3

• disposable income - the more we have the more we spend
• wealth - the value of your assets (land,houses), more assets the more money you spend - wealth effect
• inflation - if prices of products go up, you buy less
• interest rates - higher interest means people save as they get greater return
• availability to credit - availability to borrow, if you can get credit then you spend more

Question 4

What is investment?

Answer 4

• The addition to capital stock

- the investment into machinery by firms

Question 5

What are the factors that effect whether firms invest?

Answer 5

• interest rates - low interest rates mean they borrow cheaper so invest
• retained profit - can they afford to invest?
• business confidence
• state of economy - wouldn’t invest during a recession
• opportunity cost

Question 6

Why does investment drop during a recession?

Answer 6

• people are more careful with their money
• lack of confidence
• not as much disposable income, less demand so firms have less revenue
• firms have spare capacity as demand drops, no need to invest as there’s no need to increase production
• firm’s cash flows are effected, have increased costs, more money going out than in, don’t invest as don’t want reduced cash flow

Question 7

What is government spending?

Answer 7

Money spent by the government generated through taxes in the economy

Question 8

What are some examples of what the government spends money on?

Answer 8

• NHS
• merit goods
• defence
• foreign aid
• subsidies
• benefits

Question 9

If the government spends more than it receives, what happens?

Answer 9

Budget deficit

Question 10

If the government spends less than it receives, what happens?

Answer 10

Budget surplus

Question 11

What is the debt?

Answer 11

All of the deficits added up

Question 12

What determines how much trade takes place?

Answer 12

• price of goods
• tax
• exchange rates
• type of products
• income

Question 13

What is the difference between gross and net investment?

Answer 13

Gross investment measures investment before depreciation (the value of machinery depreciates over time as it wears out and is used) but net investment includes depreciation so is gross investment - depreciation

Question 14

What are the main influences on net trade balance (exports-imports)?

Answer 14

Real income
Exchange rates
State of the world economy
Degree of protectionism 
Non-price factors

Question 15

How does real income influence net trade?

Answer 15

• During periods of economic growth where people have higher incomes they consumer more creating a larger deficit on the current account
• during periods of economic decline real incomes fall which leads to improvements in the current account

Question 16

How does exchange rates influence net trade ?

Answer 16

-depreciation of the £ means imports are mor expensive, exports cheaper, current account deficit narrows

Demand for UK exports must be price elastic to lead to an increase in export, if inelastic exports won’t increase significantly and value of exports decreases

Question 17

How does the state of the world economy influence net trade?

Answer 17

A decline in economic growth in one of the UK’s export markets means there will be a fall in exports. This is because consumer spending in those economies will fall, due to falling real incomes.

Question 18

How does the degree of protectionism influence net trade?

Answer 18

Protectionism is the act of guarding a country’s industries from foreign competition. It can take the form of tariffs, quotas, regulation or embargoes. If the UK employed several protectionist measures, then the trade deficit will reduce. This is because the UK will be importing less due to tariffs and quotas on imports to the UK.

Question 19

How does non-price factors influence net trade?

Answer 19

A country can become more competitive by being innovative, having higher quality goods and services, operating in a niche market, having lower labour costs, being more productive or by having better infrastructure. These increase exports.

Question 20

what factors can change level of consumption to cause the AD curve to shift?

Answer 20

• unemployment drops, people more confident that they won’t lose jobs, more willing to borrow money and spend
• reduce interest rates, easier to borrow
• drop in income tax, people have more money to spend

Question 21

what factors can change the level of investment to cause the AD curve to shift?

Answer 21

• increase in business confidence (increase in animal spirits), because economy is going into a boom
• fall in interest rates - easier to invest
• drop in corporation tax, higher rate of return, more money to invest

Question 22

how can government spending shift the AD curve?

Answer 22

-increase in spending with no change in taxation = fall in budget surplus, increase demand
and vise versa

Question 23

how can exports and imports shift the AD curve?

Answer 23

• falling exports minus imports will decrease demand (lower exports due to higher exchange rate)
• increased exports = increase demand