Theme 2 - AD/AS

Question 1

Aggregate demand

Answer 1

Aggregate demand is the total demand in the economy. It measures spending on goods and services by consumers, firms, the government and overseas consumers and firms.
It is made up of the following components, which make up the equation:
C + I + G +(X-M)

Question 2

Downward-sloping AD curve

Answer 2

• lower prices in an economy mean increased international competitiveness, so there are more exports and fewer imports. (net exports higher at lower prices)
• the total amount of spending is approximately equal whether prices are high or low because people have approximately the same amount of money to spend, so the area under the curve is fairly constant. This is known as the real balance affect. If you plot a constant area, you’ll get a rectangular hyperbola,
• High inflation generally means the interest rates will be higher. This will discourage spending, since saving becomes more attractive and borrowing becomes expensive-AD falls

Question 3

Consumption

Answer 3

This is how much consumers (households) spend on goods and services. This is the largest component of AD and is therefore most significant to economic growth. measures how much consumers wish to spend at various price levels.

Question 4

Capital investment:

Answer 4

Investment is an increase in the capital stock - creating assets that will generate income in the future rather than in the immediate term.
This accounts for around 15-20% of GDP in the UK per annum, and about 3⁄4 of this comes from private sector firms. The other 1⁄4 is spent by the government on, for example, new schools. This is the smallest component of AD.

Question 5

Government spending:

Answer 5

This is how much the government spends on state goods and services, such as schools and the NHS. It accounts for 18-20% of GDP. Transfer payments are not included in this figure, because no output is derived from them, and it is simply a transfer of money from one group of people to another. Government spending is the third largest component of AD.

Question 6

Exports minus imports

net exports

Answer 6

This is the value of the current account on the balance of payments. A positive value indicates a surplus, whilst a negative value indicates a deficit. The UK has a relatively large trade deficit, which reduces the value of AD. This is the second largest component of AD.

Question 7

Factors that affect consumption

Answer 7

• Level of income-(people tend to save more as income increases)
• confidence of the consumer in terms of both job security and future income prospects
• interest rates
• housing market

Question 8

Gross investment

Answer 8

The total amount of investment before any account is taken of the appreciation of assets. capital loses value, wears out or becomes less efficient. many machines become less redundant as new methods of production are invented and investment of this machine does not have any long-term benefit on the economy

Question 9

net investment

Answer 9

Takes account of the fall in value of capital assets - more useful measure if you want to look at the productivity of an economy and it’s productive potential

Question 10

influences on investment

Answer 10

• confidence of firms increases investment=> indicators =
• rate of economic growth
• business expectations and confident indicators carried out by service
• what the main competitors are doing
• government incentives and regulation
• interest rates
• demand for exports
• access to credit (banks willing to lend?)

Question 11

trade cycle (business cycle)

Answer 11

The pattern of economic growth which changes from Booms to a recession or slow growth in a fairly regular pattern

Question 12

Fiscal policy

Answer 12

The deliberate manipulation of government spending and taxation in order to influence the level of AD in the economy. taxing heavily in times of abundance is a useful way to put brakes on the economy.

Question 13

Influence on government spending

Answer 13

• Trade cycle - in a boom or period of high economic growth, government expenditure is likely to fall as less demand for jobseekers allowance and other benefits; revenue from taxation is likely to rise
• National debt -which is the accumulation of budget deficit over years.

Question 14

influences on net exports

Answer 14

• level of real income
• change in exchange rates - stronger currency worsens net exports, whereas a weaker currency improves the figure. short run= price elasticity of demand for exports and imports are low- can be by contracts for specific deals and traded components are a small percentage of firm’s overall costs
• changes in the global economy - inflation in the UK but not in other countries, net exports from UK will worsen as UK goods become increasingly uncompetitive
• non-price factors such as quality and after sales

Question 15

Disposable income

Answer 15

Disposable income is the amount of income consumers have left over after taxes and social security charges have been removed. It is what consumers can choose to spend.

Question 16

marginal propensity to consume

Answer 16

A consumer’s marginal propensity to consume is how much a consumer changes their spending following a change in income.

Question 17

where can consumer income come from?

Answer 17

Consumer income might come from wages, savings, pensions, benefits and investments, such as dividend payments.

Question 18

marginal propensity to save

Answer 18

A consumer’s marginal propensity to save is the proportion of each additional pound of
household income that is used for saving.
A consumer’s marginal propensity to consume added to the marginal propensity to save is equal to 1.

Question 19

recovery stage in a business cycle

Answer 19

Real output increases when there are periods of economic growth.

Question 20

how can a country be more competitive?

Answer 20

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 21

aggregate supply

Answer 21

The amount firms are willing to supply at various price levels.
Aggregate supply shows the quantity of real GDP which is supplied at difference price levels in the economy.

Question 22

why is the AS curve sloping upwards

Answer 22

The AS curve is upward sloping because at a higher price level, producers are willing to supply more because they can earn more profits.

Question 23

SRAS curve shifts..

Answer 23

This is usually in the form of costs to businesses.

• The cost of employment might change, e.g. wages, taxes, and labour productivity. If costs increase, supply will shift inwards
• The cost of other inputs e.g. raw materials, commodity prices, and the exchange rate if products are imported. A stronger currency reduces the price of imports, so imported products will be cheaper. This would shift the AS curve outwards
• Government regulation or intervention, such as environmental laws or green taxes and business regulation. Business regulation is sometimes called ‘red tape’.
• There could be a net outward migration of workers, which causes a ‘brain drain’ on the domestic economy, as skilled workers move elsewhere.
• If there is a fall in business capital spending, supply will fall.
• taxes

Question 24

Factors influencing the long-run AS; labour market

Answer 24

*Changes in relative productivity:
A more productive labour and capital input will produce a larger quantity of output with the same quantity of input.
*Changes in education and skills:
This improves the quality of human capital, so it is more productive and more able to produce a wider variety of goods and services.
*Demographic changes and migration:
If there is net inward migration and the majority of the population is of working age, the size of the labour force is going to be significant, which means the economy can increase its output.
*Changes in health spending:
Increase in resources in healthcare sector should mean that workers have a few days off sick and active for longer. however spending on healthcare is absorbed into wage increases for staff in health services - there is little effect on the level of healthcare.
Also, majority of health care spending goes into the economically inactive

Question 25

Factors influencing the long-run AS; producer market

Answer 25

*Technological advances:
If more money is spent on improving technology, the economy can produce goods in larger volumes or improve the quality of goods and services produced.
*Competition policy:
A more competitive market encourages firms to be more efficient and more productive, so they are not competed out of business. Governments can use effective competition policy to stimulate this in the economy.
*Changes in government regulations:
Government regulation could limit how productive and efficient a firm can be if it is excessive. This is sometimes referred to as ‘red-tape’.

Question 26

factors influencing the long-run AS (GENERAL)

Answer 26

The LRAS curve is influenced by changes which affect the quantity or quality of the factors of production. This is equivalent to shifting the PPF curve i.e. when the economy is operating at full capacity.

Question 27

wealth effect.

Answer 27

In the UK, most people own their houses. This means that a rise in the price of houses makes people feel wealthier, so they are likely to spend more.