LS3 AD

Question 1

What does a balance of payments account show?

Answer 1

It is a record of all financial dealings over a period of time between economic agents of one country and all other countries

Question 2

What does a current account show?

Answer 2

It records payments for the purchase and sale of goods and services

Question 3

What does the capital and financial accounts show?

Answer 3

Flowsof money associated with saving, investment,, speculation and currency stabilisation

Question 4

Describe the components that the current account on the balance of payments is split into

Answer 4

– Trade in goods is often called trade in visibles. This is trade in raw materials, such as copper oil, car components and mobile phones. The difference between the value of visible imports and visible. Imports is known as a balance of trade.
– trade in services, including financial services, such as banking and insurance transport services, such as shipping and air, travel and tourism. This is an example of trade in invisibles. These are intangible services. These are called debits on the official UK balance of payment account.
– Primary and secondary income: most of this income is generated from interest, profits, and dividends on assets owned abroad. Another income comes from repatriation of earnings from national workers in foreign countries. Another kind of income is financial aid. Most of the secondary income is movement of money which is not paying for goods or services or investment

Question 5

How do you calculate the balance of trade and current balance?

Answer 5

– To calculate balance of trade; exports – imports

– To calculate current balance: balance of trade, + primary and secondary - minus debit

Question 6

What would cause a current account deficit and what would cause a current account surplus?

Answer 6

A current account deficit would be caused by imports being greater than exports, and the money flowing out of the country from trade in goods and services as well as primary/secondary income are greater than the monies flowing into the country from these transactions
A current account surplus would be the opposite .

Question 7

What are some reasons for a trade deficit?

Answer 7

– Week export caused by tariffs or barriers
– High global prices for essential imports
– Currency weakness

Question 8

What are some consequences of current account deficit?

Answer 8

– Currency weakness
– Slower economic growth
– Need to attract capital flows

Question 9

What are the macroeconomic objectives?

Answer 9

– low unemployment
– Balance of payments at an equilibrium
– low and stable inflation rate
– Economic growth on par with other similar economies

Question 10

Define aggregate demand

Answer 10

The total amount of spending on goods and services produced in an economy during a period of time

Question 11

Who are the key economic agents in the context of aggregate demand?

Answer 11

Households and firms and the government

Question 12

How do I calculate aggregate demand?

Answer 12

Consumption+ investment+ government spending+ net exports

Question 13

Explain the three reasons for the downward sloping A.D. curve

Answer 13

• The wealth effect: changes in the price level affect the real value of peoples wealth, which is the value of assets that people own. As price level increases, the real value of wealth falls causing reduced consumer confidence and a decrease in spending. As price level falls, the real value of wealth increases so consumer confidence increases and spending increases.
• The International trade affect: if domestic price level increases while the price levels in other countries remain the same exports become more expensive to foreign buyers, and to domestic buyers goods produced in other countries become cheaper = aggregate demand decreases. If domestic price level decreases while the price level in other countries remains the same exports become cheaper to foreign buyers, for domestic buyers good produced in other countries become more expensive = aggregate demand increases.
• The interest-rate affect: changes in price level impact interest rate. If there is an increase in price level, then consumers in firms need more money to do purchases and transactions which would lead to an increase in the demand for money and an increase in the interest rate as the interest rate increases the cost of borrowing increases so consumer purchases financed by borrowing falls as well as investment. Hence increases in price level little fall in aggregate demand. A fall in price level will lead to a rise in aggregate demand.

Question 14

What could cause a fall in A.D. and a rise in Ad

Answer 14

A fall in A.D. could be caused by:
A fall in net exports, cuts in government spending, higher interest rates, decline in household wealth
A rise in AD could be caused by:
An increase in household wealth (house prices increase), depreciation on the exchange rate, cuts in direct/indirect taxes, expansion on supply of credit, lower interest

Question 15

What would cause a shift in the aggregate demand curve?
What would cause a movement in the aggregate demand curve?

Answer 15

A change in the determinants of aggregate demand (consumption, investment, government spending, or net exports)
A change in the price level

Question 16

Define consumption

Answer 16

Consumption is the total planned household spending

Question 17

State and explain the determinants of consumption

Answer 17

• Changes in consumer confidence: this is a measure of how optimistic consumers are about their future. If they are optimistic than they expect incomes to increase and the future of the economy to be stable, so are more likely to spend on buying goods and services causing AD to shift right. If consumers are not confident, then they expect incomes to decrease or are worried about unemployment, and the future of the economy to be questionable so they would rather save causing decreases in AD.
• Changes in interest rates: a lot of spending is financed by borrowing an increase in interest rates makes borrowing more expensive, causing a fall in AD. A fall in interest rates would cause boring to become cheaper, causing a rise in AD
• changes in wealth: an increase in consumer, while (caused by an increase in stock market values or the value of homes) would cause aggregate demand to increase. A fall in well known as aggregate demand. This could be caused by a change in personal income taxes. (Changes in taxes, are the result of a fiscal policy).
• Changes in the level of household indebtedness: if consumers have a high level of debt, then they are under pressure to make monthly payments to pay back loans, plus interest, so are likely to cut back on expenditure. A high level of indebtedness causes a decrease in AD where is a low-level of indebtedness causes an increase

Question 18

Define disposable income

Answer 18

The income that households have to devote to the consumption and saving, taking into account payments of direct taxes and transfer payments

Question 19

Define average propensity to consume

Answer 19

This is the proportion of income that households devote to consumption

Question 20

Define marginal propensity to consume

Answer 20

(MPC): the proportion of additional income devoted to consumption

Question 21

Define marginal propensity to save

Answer 21

MPS: the proportion of an increase in disposable income that households would devote to saving

Question 22

Define investment

Answer 22

In addition to the capital stock of the economy, factories and machines offices and stocks of materials used to produce other goods and services. Investment only takes place if real products are created for example, putting money into a bank account would be saving, but the bank buying a computer to handle an account would be an investment.

Question 23

What is the difference between gross and net investment?

Answer 23

Gross investment is the investment before depreciation or capital consumption. Where is net investment is just the total value of all the investments (gross investment – depreciation).
For example, a company bought 3 computers and 1 broke so they 1 more computer to replace the broken one. Gross investment would be 4 computers, whereas net investment would be 3 computers.

Question 24

What is the difference between investment in physical and human capital?

Answer 24

Investment in Physical capital is investment in factories etc
Investment in human capital is investment in the education and training of workers

Question 25

What variable affect the level of investment?

Answer 25

Interest:
- Some investment is financed by borrowing therefore interest which would be paid on a loan would be part of the cost of an investment project. A high rate of interest would discourage investment as it will become unprofitable, whereas a low interest rate will encourage firms to invest more as the number of profitable investment project will increase.
- Some investment is financed by retained profit. The higher the rate of interest that banks offer on savings are more attractive. It is for firms to save money rather than invest it. Hence, a low rate of interest would incentivise firms to invest.

Question 26

What are the determinants of investment?

Answer 26

• changes in business confidence: if firms are optimistic, they spend more on investment, whereas if they are pessimistic investment decreases
• Changes in interest rates: interest impact the cost of borrowing and forces businesses to either increase or reduce spending because of the cost of borrowing
• Changes (improvements) in technology: an improvement in technology, stimulates investment
• Changes in business taxes: if the government increases tax on profits for businesses, investment spending decreases because profits fall. Hence a decrease in taxes on profits result in increased AD
• The level of corporate indebtedness: its businesses have high levels of debt, they will be less inclined to make investments and therefore low levels of debt will encourage investment
• Legal/institutional changes: sometimes the legal and institutional environment impacts investment spending, especially when small businesses are not favoured by laws and institutions. For example, small businesses do not have often access to credit meaning they can’t borrow to finance investments. On top of this. There are a lack of laws that secure property rights (legal rights to ownership). Increasing access to credit and securing property rights with increased investment.

Question 27

Which two variables impact government expenditure/government spending?

Answer 27

• changes in political priorities: expenditure can increase or decrease if the government decides to spend more or less on subsidies/pensions/payments of wages and salaries, to its employees/purchases of goods for its own use etc
• Changes in economic priorities: deliberate effort to influence aggregate demand: the government can use its own spending to deliberately influence aggregate demand

Question 28

What impacts net trade?

Answer 28

– Changes in national income abroad: this country, a house links with country P and country be is national income increases. It will import more from country so that countries exports will increase. Therefore A.D. curve in country A shift right.
- Changes in exchange rates: if country X experiences an increase in the value of its currency country Z will find X is output more expensive. At the same time country X finds countries adds goods and services cheaper so they will import more.. hence an increase in country exes currency will produce a fall in exports and an increase in imports.
- Changes in the level of trade protection: there may be restrictions to international trade imposed by the government. If one country can trade freely, but another cannot, the first country’s net exports may be lower.

Question 29

What is the balance of payments split into?

Answer 29

• Balance of trade in goods and services
• primary income
• Secondary income

Question 30

What transfers make up primary income

Answer 30

Income from capital investment
Interest on loans
Dividends from shares
Remittances or benefits