Macroeconomics Aggregate Demand Theme 2

Question 1

Aggregate Demand definition

Answer 1

Total demand for goods are services in the economy

Question 2

4 Main components of aggregate demand

Answer 2

Consumption (C)
Investment (I)
Government Spending (G)
Net Exports (X-M)

Question 3

Reasons why aggregate demand curve slopes downwards against real gdp and price levels

Answer 3

The real balance effect: An increase in the average price level reduces the purchasing power of households, businesses, government and the foreign sector, so reducing the quantity of real output demanded.
The international competitiveness argument: at higher average prices, an economy is less likely to export as they are less competitive and are more likely to export, this decreases the X component and increases the M component of AD.
Interest rate arguments: at higher average prices, the interest rate is likely to be higher, meaning businesses will invest (I) less and consumers will consume (C) less too

Question 4

What is a movement along the aggregate demand curve caused by

Answer 4

Caused by a change in price level ad is either called an expansion or contraction

Question 5

What causes a shift in AD

Answer 5

Caused by a change un the components of AD, such as consumption, investment, government spending and net exports.

Question 6

Definition of consumption

Answer 6

The total amount households spend on goods and services over a period of time

Question 7

Factors influencing consumption (no explanation)

Answer 7

Consumer income
Changes in income taxation
Consumer confidence
Availability of credit
Interest rates
Wealth effect

Question 8

How does consumer income affect consumption and therefore AD

Answer 8

If consumers have more income to spend they are able to consume more goods and services boosting AD

Question 9

How does changing in income taxation affect consumption and therefore AD

Answer 9

Lower income taxation means workers will have more disposable income and therefore more opportunity to spend on goods and services

Question 10

How does consumer confidence affect consumption and therefore AD

Answer 10

If consumers are more confident they will be more willing to spend their income rather than undertaking precautionary saving

Question 11

How do wealth effects affect consumption and therefore AD

Answer 11

If consumers have greater wealth then consumers have more confidence which allows greater consumption. Consumers could also sell their assets to fund greater consumer spending.

Question 12

How do interest rates affect consumption and therefore AD

Answer 12

If interest rates fall then this should encourage consumption as there is less incentive to save, more incentive to borrow and homeowners on variable mortgage will have less interest payments.

Question 13

How does availability of credit affect consumption and therefore AD

Answer 13

If credit becomes more available for consumers then consumers will be able to borrow more easily to finance spending

Question 14

Defintion of investment

Answer 14

Spending on capital goods which can be used to create products to sell i.e. increasing the capital stock of the economy

Question 15

Gross investment meaning

Answer 15

Spending on capital goods, before depreciation is taken into account

Question 16

Net investment meaning

Answer 16

Spending on capital goods, after depreciation is taken into account

Question 17

Relationship between gross and net investment

Answer 17

Gross investment - depreciation = net investment

Question 18

What is meant by capital depreciation

Answer 18

Some investment is needed each year just to replace technology obsolete or worn out plant and machinery

Question 19

Factors influencing investment

Answer 19

The rate of economic growth
Keynes animal spirit
Interest rates
Business expectations and confidence
Access to credit
Government subsidies
Corporation tax
Demand for exports

Question 20

How does the rate of economic growth affect investment and therefore AD

Answer 20

A high level of economic growth should mean that employment is high. This means there is more incentive to invest in capital goods as businesses are more confident of getting a return on their investment, as consumers are likely to consumer more goods and services as they are employed and earning income.

Question 21

How does business expectations and confidence affect investment and therefore AD

Answer 21

If businesses have high levels of business confidence and expectations they are more likely to invest, such as when the economy is growing and consumers are spending. Therefore, businesses can invest as they are more likely to make a return on this investment as there is perceived to be lower risk of expansion.

Question 22

How does Keynes’ and animal spirits affect investment and therefore AD

Answer 22

Often the crucial deciding factor will be expectations about the future performance of the economy. When in general business exceptions are optimistic, many investors take risks which they would not take if expectations were gloomy, once they see others doing this they become more likely themselves to take risks due to a herd instinct.

Question 23

How does demand for exports affect investments and therefore AD

Answer 23

Higher demand for exports, the more incentive there is to invest and expand the business by purchasing capital goods to maximise profits which would allow more exports to be produced at possibly lower costs or highly quality.
Moreover, when demand for exports is high, firms should haver high profits with which to invest and expand their business

Question 24

How does interest rates affect investment and therefore AD

Answer 24

Interest rates can encourage investment if they are low as this makes financing borrowing cheaper and gives less incentive to save rather than invest.
It also boosts consumer spending and so therefore business confidence and investment should also increase.

Question 25

How does access to credit affect investment and therefore AD

Answer 25

If banks are willing to lend then firms will have the finances to invest in capital goods.

Question 26

How does government subsidies affect investment and therefore AD

Answer 26

Government subsidies encourage production as they are a source of finance that can be used by firms to invest in capital goods

Question 27

How would cooperation tax affect investment and therefore AD

Answer 27

Corporation tax is a tax on business profits, if corporation tax is lowered, then there is more incentive to invest as a smaller amount of the resulting profit will be taken in tax.
Moreover, lower corporation tax also gives businesses more profits after tax in order to finance purchasing new capital goods.

Question 28

What are the two main influences on government spending

Answer 28

Fiscal Policy
The Trade Cycle

Question 29

What is fiscal policy

Answer 29

The government may decide to change the level of spending in the economy when they change fiscal policy. This is known as discretionary fiscal policy

Question 30

How does fiscal policy affect AD

Answer 30

Austerity to reduce the government budget would lead to a reduction in AD, but increased government spending would boost economic growth and AD

Question 31

What is the trade cycle

Answer 31

A trade cycle refers to fluctuations in economic activities specially in employment

Question 32

How does the trade cycle affect AD (example)

Answer 32

During a recession more workers will be made unemployed so government will spend more on unemployment benefits boost AD slight and reduce fall of GDP
During a boom the opposite will happen

Question 33

What are net exports

Answer 33

The value of exports minus the value of imports (X-M)

Question 34

What determines the exchange rate

Answer 34

Supply and Demand

Question 35

Impact on exchange rate changes

Answer 35

• SPICED Stronger Pound Imports Cheaper Exports Dearer - This would worsen the Uk’s net export position
• WPIDEC Weaker Pound Imports Dearer Exports Cheaper - Improve the UK’s net export position

Question 36

How does UK incomes affect next exports and therefore AD

Answer 36

• As imports tend to be normal goods as income rises the imports tend to increase too as the UK have a high marginal propensity to import. This will mean a reduction in net exports.

Question 37

How does UK inflation affect net exports and therefore AD

Answer 37

If the UK is experiencing high rates of inflation this could increase the costs for UK firms and make them less internationally competitive reducing the demand for UK exports as well as causing UK to switch to buying more competitive imports from abroad

Question 38

How does the state of the world economy affect net exports and therefore AD

Answer 38

If UK export markets see their economic growth rates fall, then this will reduce UK exports prospects and decrease net exports as foreign consumers feel less confident.

Question 39

What is protectionism

Answer 39

Protectionism are measures that reduce free trade such as tariffs (tax on imports) and quotas (limit on imports).

Question 40

How does the degree of protectionism affect net exports and therefore AD

Answer 40

If the EU increase protectionism, then this will reduce imports into the UK as they either are less price competitive or there is a limit to the number of imports
Moreover, if UK export markets reduce protectionism on UK products then this allows UK to export abroad

Question 41

How do non-price factors affect net exports and therefore AD

Answer 41

For some products foreign customers may buy UK exports based on non price factors such as quality and design rather than price. An improvement in non-price factors will boost UK exports and therefore net exports

Question 42

Factors influencing net exports (6)

Answer 42

• Exchange rate
• UK income
• Uk inflation
• Economic state of the world
• Degree of protectionism
• Non-price factors

Question 43

Limits to greater export prospects (2)

Answer 43

Time to switch - in the short term consumers and companies may be stuck in contracts
Lack of UK manufacturing capacity - If UK does not have the capacity to export effectively they cannot take advantage of greater export opportunities