Theme 2 - Aggregate demand

Question 1

what is aggregate demand

Answer 1

the total demand for a countries goods and services at a given price level in a given time

Question 2

equation for AD

Answer 2

C + I + G + ( X - M)

Question 3

what does it mean when the AD demand curve is downward sloping

Answer 3

it means that AD is changing purely because of reasons to do with price

Question 4

what does the wealth effect say

Answer 4

• When the value of assets such as property, stocks, or savings rises, individuals perceive an increase in their overall wealth
• People may feel more financially secure and willing to make significant purchases or spend on luxury items.
• Increased consumer spending stimulates demand for goods and services, which can drive economic growth
• and vice versa

Question 5

what does the trade effect say

Answer 5

• a fall in the price level causes exports to become more competitive and imports to become less competitive. this means the demand for exports will increase and revenue generated from exports will increase. less spending on imports will reduce M

Question 6

what does the interest effect say

Answer 6

if the price level falls, interest rates can be kept lower in the economy, as most central banks will adopt interest rate policies to meet an inflation target,
- lower interest rates stimulate consumption, stimulates higher investments as the cost of borrowing is lower, also reduces the value of exchange rates, boosting export performance

Question 7

when is there a shift in AD

Answer 7

when C,I,G,X, or M changes, nothing to do with price level

Question 8

what is consumption

Answer 8

the total spending by households on goods and services in the economy

Question 9

how much does consumption account for

Answer 9

around 66 percent of AD

Question 10

what is the MPC

Answer 10

the marginal propensity to consume is the willingness of a household to spend any extra income that they earn

Question 11

what factors can affect consumption

Answer 11

• level of disposable income, eg if income taxes are cut, more disposable income to spend
• interest rates, eg a fall in interest rates, return on savings and cost of borrowing falls, increasing incentive for consumers to borrow and spend money
• availability of credit - if availability is low, it can reduce the impact of fall of interest rates
• consumer confidence - higher confidence = higher MPC
• Asset prices - the higher the asset prices, the richer people feel, increasing their likelihood of spending, higher MPC
• household indebtedness - famillies living with more debt are more likely to save money, in case things go bad, but families w less debt are more likely to spend

Question 12

what can impact consumer confidence

Answer 12

• job prospects, if people believe they are likely to get promoted,their MPC may increase
• level of unemployment in the economy, people will feel more confident and secure in their job, making them spend more

Question 13

Examples of asset prices

Answer 13

• house prices
• share prices
• bond prices

Question 14

why do governments spend money

Answer 14

to influence the level of economic activity to influence both short and long run growth

Question 15

what are the types of government spending which can take place in the economy

Answer 15

• current spending - the spending on the maintenance of public services and public sector wages
• capital spending - spending on infrastructure projects, like railway lines
• welfare spending - spending on benefits and pensions, eg disability and child support, biggest part of govt spending

debt interest payments - when govt take out money out of the international bank, interest is added on that needs to be paid

Question 16

how much money goes to debt interest payment

Answer 16

around 50 billion pounds

Question 17

what is a budget deficit

Answer 17

when govt spending is greater than tax revenue in a fiscal year

Question 18

what is a budget surplus

Answer 18

where govt spending is less than tax revenue in a fiscal year

Question 19

what is national debt

Answer 19

the total stock of debt over time, the accumulation of budget deficits

Question 20

what would cause AD to shift to the right

Answer 20

an increase in CIGXM

Question 21

what will an outward shift of AD do

Answer 21

will raise national output at all price levels

Question 22

what would an inward shift of AD do

Answer 22

reduce national output at all price levels

Question 23

what does X and M represent in the AD equation

Answer 23

• export revenue coming into the country
• import expenditure

Question 24

what factors can influence the level of net exports (X - M)

Answer 24

• real disposable income earned abroad, if there is a boom in the country abroad, the citizens are getting richer, their MPC to import goods likely to increase, Strong economic growth in the domestic country increases income and spending power, leading to higher demand for imports, the demand for exports likely to increase, shifting AD to the right, and vice versa
• real disposable income earned at home, boom in the UK, the MPC to import likely to rise, import expenditure likely to rise, shifting AD to the left, vice versa
• exchange rates - (SPICED and WIDEC), eg a strong exchange rate, cheap imports, demand for imports will rise and so will expenditure on imports, exports are more expensive, demand will fall, shifting AD left,revenue generated from exports will fall, vice versa
• protectionism from home and abroad, non tariff barriers, sanctions etc, may prevent trade with other countries, may reduce the revenue that can be generated through exports, strong protectionism abroad means X will be lower, shifting AD to the left and vice versa if there is strong protectionism of imports at home
• relative inflation rate at home - if the inflation rate at home is greater than that overseas, exports will be less competitive, demand for exports will decrease, the amount of export revenue will be lower, shifting AD to the left, vice versa
  • import expenditure also increase if inflation is high, may be cheaper to buy things abroad as they can be imported

Question 25

what does SPICED and WIDEC stand for

Answer 25

• strong exchange rate, imports cheap, exports dear
• weak exchange rate, exports cheap, imports dear

Question 26

what is investment

Answer 26

when firms spend money on capital goods to increase their productive capacity

Question 27

what factors can affect investment

Answer 27

• interest rates - low interest rates = lower cost of borrowing, firms have a greater incentive to borrow money and invest, reaching hurdle becomes easier, AD will shift right, vice versa
• Business confidence - if the expectations of profit and demand for the economy is high, businesses marginal propensity to invest likely to be high, to meet their level of demand in the future, vice versa
• Level of corporation tax -the lower the corporation tax, the higher the level of retained profit, the greater potential the business has to invest as they can use the retained profit to invest, AD shifts right, vice versa
• Spare capacity - if space capacity is high, there is no need to invest in things such as machinery as current ones are not being used up, AD shifts left, and vice versa
• level of competition - if competition is strong, businesses are more likely to invest, to get on the same level or better than their rivals, ad right
• price of capital - low price, investment is cheaper, marginal propensity to invest increases, shifting AD to the right and vice versa

Question 28

what are interest rates

Answer 28

• cost of borrowing
• reward for saving

Question 29

what is the hurdle

Answer 29

the required rate of return firms need for investment projects to go ahead

Question 30

what is business confidence determined by

Answer 30

• expectation of future profit
• expectation of future demand in the economy

Question 31

what is retained profit

Answer 31

the profit left after corporation tax has been paid

Question 32

what is corporation tax

Answer 32

a tax on business profits

Question 33

what is the accelerator effect

Answer 33

when there is an increase in rate of real gdp in the economy and that encourages further investment

Question 34

what are savings

Answer 34

the part of disposable income which is not spent on goods and services in the economy

Question 35

how do savings contribute to the increase or decrease in AD

Answer 35

• increased savings will decrease consumption, which is a variable in the AD equation, and vice versa

Question 36

factors which can affect savings

Answer 36

• the level of real disposable income, higher income can increase both spending and saving
• interest rates, higher interest rates will encourage saving, as rate of return will be higher, increased marginal propensity to save, shifts AD left and vice versa
• consumer confidence - low consumer confidence because of something like fear of recession, encourages more saving and less spending
• range/ trustworthiness of financial institutions - in developing countries, banks may be less trustworthy, higher levels of corruption may decrease the marginal propensity to sav, increasing consumption
• education - if individuals know the benefits of saving, they would be more likely to save more
• tax incentives, eg ISAs - govt policies to encourage savings may increase marginal propensity to save, dont have to pay income tax
• age structure of population - younger people are likely to spend money and consume, older more likely to save their money, pensions etc

Question 37

evaluation points for things than affect exports

Answer 37

• Exchange rate fluctuations can have immediate impacts on trade balances, but long-term effects depend on the elasticity of demand for exports and imports. For instance, if demand is inelastic, the volume of trade might not change significantly
• J-Curve Effect: In the short term, a depreciation of the domestic currency might initially worsen the trade balance before improving it, as contracts and trade adjustments take time
• if a trading partner is in a recession or contraction phase, its demand for imports decreases. The UK’s exports to this country may decline, leading to a reduction in net trade balance.
• Protectionist policies, such as tariffs and quotas, can lead to retaliatory measures from other countries, potentially harming exports and escalating trade wars

Question 38

Explain the J curve

Answer 38

SHORT RUN
- After a currency depreciation, the prices of imports rise immediately,imports more expensive.
- Export prices in foreign currency terms may not adjust as quickly, causing the value of exports to remain relatively unchanged initially.
- As a result, the trade balance worsens because the higher cost of imports outweighs the unchanged value of exports.

LONG RUN
- Over time, consumers and businesses adjust to the new prices. Import volumes start to decline due to higher costs, and export volumes increase as foreign demand rises for relatively cheaper goods

• Eventually, the trade balance improves as the volume effects of increased exports and reduced imports outweigh the initial price effects. The increased competitiveness of the country’s goods leads to higher export revenues, and the reduced import demand lowers import expenditures.