Aggregate Supply and Demand Definitions

Question 1

Aggregate demand (4)

Answer 1

The total demand for final goods and services in an economy at a given time (1). It is made up of spending from four different groups: consumers (consumption), firms (investment), the government (government spending) and overseas buyers (net exports) (4).

Question 2

Aggregate supply (2)

Answer 2

Aggregate supply shows total planned output for the economy at a given price level (1). Factors that influence the level of AD relate to any change in the cost or quality of the factors of production (1).

Question 3

Consumption (1)

Answer 3

Consumption expenditure, which is the purchase of goods and services for use by households (1).

Question 4

Investment (3)

Answer 4

Investment is spending by firms (1) that may be for two reasons: 1) spending on capital to replace depreciation (1); 2) as an addition to capital stock (1).

Question 5

Government spending (3)

Answer 5

Central government spending in the United Kingdom, also called public expenditure (1). It is made up of current spending, capital spending and transfer payments (1). In the financial year 2015-16, total government spending was £772 billion (1).

Question 6

Net exports (2)

Answer 6

Net exports are the difference between a country’s total value of exports and total value of imports (1). Depending on whether a country imports more goods or exports more goods, net exports can be a positive or negative value. In the UK, net exports is negative because the value of imports is greater than the value of exports (1).

Question 7

Injections (2)

Answer 7

Injections into the circular flow are additions to investment, government spending or exports(1) so boosting the circular flow of income (1) leading to a multiplied expansion of output.

Question 8

Withdrawals (2)

Answer 8

Withdrawals are increases in savings, taxes or imports (1) so reducing the circular flow of income (1) and leading to a multiplied contraction of production (output).

Question 9

The multiplier effect (4)

Answer 9

The multiplier effect is where an original injection into the circular flow of income leads to secondary spending rounds and a multiplied expansion of output (1). The size of the multiplier depends upon household’s marginal propensity to consume (mpc) (1). The size of the multiplier can be calculated using 1/(1-MPC) (1) or 1/MPW, where MPW=MPS+MPT+MPM (1)

Question 10

Wealth effects (2)

Answer 10

The wealth effect is a behavioural economic theory which suggests that consumer spending increases significantly when asset values rise (1). E.g. rising house prices makes homeowners to feel financial secure and reduce their MPS and increase their MPC (1).

Question 11

Rate of return (1)

Answer 11

The annual income from an investment expressed as a proportion (usually a percentage) of the original investment. (1)

Question 12

Output gap (4)

Answer 12

A negative output gap is the amount by which the actual output of an economy falls short of its potential output or trend output (1). A visible symptom of this spare capacity in an economy would be unemployment or empty shops (1). A positive output gap is the amount by which the actual output of an economy exceeds the trend output (1). A positive output gap is associated with an economy at risk of inflationary pressure (1).