Macro Topic 2- AD determinants

Question 1

List the components of AD

Ad component= consumption

Answer 1

Consumption
Investment
Government spending
Exports- imports= NET exports

Question 2

Name the 5 factors which can affect consumption (independent of the price level)

(Ad component= consumption)

Answer 2

1) Level of real disposable income
2) Interest rates/ availability of credit
3) Consumer confidence
4) Asset prices
5) Household indebtedness

Question 3

Explain how having an increase in the level of real disposable income impacts consumption and so therefore impacts AD?

(Ad component= consumption)

Answer 3

• if income taxes are cut
  E.g: cuts in the marginal rate of income tax
• This will increase the level of real disposable income
• increases the MPC (marginal propensity to consume)
• increases consumption
• increases AD

Question 4

Explain how interest rates being cut affects consumption and therefore impacts AD?

(Ad component= consumption)

Answer 4

• if interest rates are cut
• cost of borrowing falls
• because the cost of borrowing falls, consumers have an incentive to go and borrow now because it is cheaper to do this.
• may spend money on expensive items
• consumption increases, and so AD increases
• if interest rates are cut
• rate of return on savings falls
• reduces incentive to save
• any income generated results in consumption
• consumption increases and so AD increases

Question 5

Explain the relationship of availability of credit and interest rates and link this to consumption and AD.

(Ad component= consumption)

Answer 5

• if there is low availability of credit
• reduces impact of borrowing and low interest rates
• because banks are not willing to lend
• this affects consumption because it can stop it from happening

Question 6

Explain how consumer confidence affects consumption and therefore impacts AD

(Ad component= consumption)

Answer 6

• if consumer confidence is high

- Consumers have a high MPC

Question 7

What 2 factors affect consumer confidence?

Ad component= consumption

Answer 7

• if people expect that they might get promoted soon or that their job prospects are very strong
• then their MPC is likely to be higher.
• If level of unemployment is very low then individuals are likely to feel confident and MPC will be high as they may think there is less/no need to save up

Question 8

Explain how asset prices affects consumption and therefore impacts AD.

(Ad component= consumption)

Answer 8

• linked to wealth
• the wealthier people feel the higher their MPC.
• asset prices e.g: House prices, share prices
• if these increase and people have these assets people feel wealthier and so they are more likely to spend money.
• increases consumption and so AD increases.

Question 9

How does the level of household indebtedness affect consumption/ AD

(Ad component= consumption)

Answer 9

• huge household indebtedness
  (people living in huge debts)
• people are
  more likely to save their money
• in case they need to repay their debts quick so they would save more.

Lower consumption if there is high household indebtedness.

Question 10

What is the relationship between savings and consumption?

Answer 10

• As savings increase, consumption decreases.

Question 11

List the determinants of savings

Answer 11

1) Level of real disposable income
2) Interest rates
3) consumer confidence
4) Range/ trustworthiness of financial institutions
5) Tax incentives
6) Age structure of population

Question 12

Explain how real disposable income affects savings…… which also impacts consumption.

Answer 12

• if incomes rise
• consumption can increase, but people can save more and so MPC decreases.
• so the level of real disposable income can defo affect level of saving.

Question 13

Explain how interest rates affects savings…… which also impacts consumption.

Answer 13

• high interest rates increase the marginal propensity to save and so decrease MPC.
• higher interest rates= encourage more saving
• rate of return on saving increases
• if you save your money in a bank and interest rates are high= nice rate of return
• increases incentive to save more money.
• low interest rate= does opposite, encourages borrowing & spending.

Question 14

Explain how consumer confidence affects savings…… which also impacts consumption.

Answer 14

• low consumer confidence maybe because of fear of losing job or recession.
• individuals= take cut in consumption and so they save more.

opposite with high consumer confidence-
- encourages less savings & more consumption.

Question 15

Explain how range/ trustworthiness of financial institutions affects savings…… which also impacts consumption.

Answer 15

• in developing countries there may be preventions to savings!
• poor range of institutions
• banks may not exist in the form that they are in developed countries.
• may be corrupt institutions.
• may lack the education about the benefits of savings.

barrier to savings.

Question 16

Explain how tax incentives affects savings…… which also impacts consumption.

Answer 16

• these are govt policies to encourage more savings.
• e.g.: ISA
• individuals savings account….
• where people can have savings and earn returns on them which are tax free…. up to a certain threshold.

Question 17

Explain how age structure of population affects savings…… which also impacts consumption.

Answer 17

middle aged= more likely to save money for children and retirement

• youngers= 15-30 years AND old people above 60… more likely to spend their money

if the population is consisting of majority middle aged people there will be more saving in the economy and so less consumption.