topic 2.2

Question 1

What is Aggregate Demand (AD) and the equation

Answer 1

Aggregate demand (AD) is the total level of spending in the economy at any given price
AD= C+I+G+(X-M)

Question 2

What does C stand for in the AD formula and the % of AD

Answer 2

C stands for Consumption. Consumption is consumer spending on goods and services; it makes up about 60% of AD, so is the biggest part.

Question 3

What does I stand for in the AD formula and the % of AD

Answer 3

I stands for Investment. Investment is spending by businesses on capital goods, such as new equipment and buildings as well as working capital ; it makes up about 15-20% of AD. Most investment is by the private sector (about 75%) but there is also investment by the government.

Question 4

What does G stand for in the AD formula and the % of AD

Answer 4

G stands for Government spending. Government spending is spending by the government on providing goods and services, generally public and merit goods, both on wages and salaries of public sector workers. Government spending tends to be around 18-20% of GDP.

Question 5

What does (X-M) stand for in the AD formula and the % of AD

Answer 5

(X-M) is Net trade. Net trade is exports minus imports: when imports are higher than exports this is a minus figure as more money leaves the UK than comes in. Least significant part of AD at around 5%.

Question 6

What causes the movement along the AD curve

Answer 6

A movement along the AD curve is caused by a change in prices , caused by inflation or deflation

Question 7

What causes a shift of the AD curve

Answer 7

A shift of the AD curve is caused by a change in any other variable . Again, as with demand, a shift to the right represents an increase in AD and a shift to the left represents a fall in AD.

Question 8

What is disposable income (Y)

Answer 8

Disposable income (Y) is the money consumers have left to spend , after taxes have been taken away and any state benefits have been added.

Question 9

Explain marginal propensity to consume (MPC) including the formula

Answer 9

MPC is how much an increase in income affects consumption.
MPC= change in consumption / change in income

Question 10

Explain MPC in terms of population e.g.., average consumer, poor consumer

Answer 10

For most people, MPC will be positive but less than 1
Poorer people tend to have a higher MPC as they are likely to spend much more of their increase in income whilst richer people are more likely to save it.

Question 11

Explain Average propensity to consume (APC) including the formula

Answer 11

The average propensity to consume (APC) is the average amount spent on consumption out of total income
APC = total consumption / total income

Question 12

Explain Marginal propensity to save (MPS) including the formula

Answer 12

The marginal propensity to save (MPS) is how much of an increase in income is saved
MPS= change in savings / change in income

Question 13

Explain Average propensity to save (MPS) including the formula

Answer 13

The average propensity to save (APS) is the average amount saved out of income.
APS= total savings / total income

Question 14

What are the other 5 influences on consumer spending

Answer 14

1) Interest Rates
2) Consumer confidence
3) Wealth effects
4) Distribution of income
5) Tastes and attitudes

Question 15

What is Gross investments

Answer 15

Gross investment is the amount of investment carried out and ignores the level of depreciation

Question 16

What is net investment

Answer 16

Net investment is gross investment minus the value of depreciation

Question 17

What are the 7 influences on investment

Answer 17

1) Rate of economic growth
2) Business expectations and confidence
3) Keynes and ‘animal spirits’
4) Demand for exports
5) Interest rates
6) Access to credit
7) The influence of government and regulations

Question 18

Explain Rate of economic growth’s influence on investment

Answer 18

In a growing economy, there will be higher levels of investment as businesses would be more confident about their investments and the higher demand would lead to a higher return rate on the investment.

Question 19

Explain Business expectations and confidence- ‘Animal spirits’ influence on investment

Answer 19

When businesses are confident about the future and expect future growth, investment will increase as they want to prepare for the future. If they are fearful of the future, then they will not invest money in new ideas or machinery. John Maynard Keynes used the term ‘animal spirits’ to describe the feeling of managers and owners of firms on whether their investment would be profitable.

Question 20

Explain Demand for exports influence on investment

Answer 20

If the world economy is booming, demand for exports is
likely to increase and therefore exporting firms’ investment is likely to increase to cope with this extra demand. This will have a knock-on effect and encourage other firms to increase their investment

Question 21

Explain Interest rates influence on investment

Answer 21

Most investment is done through borrowing. High interest rates
mean that borrowing is more expensive, so a business needs to be more confident of good profits in order to cover the extra costs of borrowing. Other investment is done through retained profits or savings. A rise in interest rates increases the opportunity cost of a business using retained profits as they are able to get higher interest
payments than before.

Question 22

Explain Keynes’ Marginal efficiency of capital graph

Answer 22

Keynes’ Marginal Efficiency of Capital (MEC) graph shows
how higher interest rates will lead to a fall in investment. This displays the expected rate of return from an investment at a particular given time

Question 23

Explain Influence of government and regulations influence on investment

Answer 23

Governments can encourage investment by their own policy decisions.

Question 24

Explain Access to credit influence on investment

Answer 24

Investment will be lower when an investment has a high risk attached to it, as it means there will be less access to credit and interest rates will be higher

Question 25

What are the 2 influences on government expenditure

Answer 25

1) The trade cycle
2) Fiscal policy

Question 26

Explain The trade cycle’s influence on Government expenditure

Answer 26

In a recession, the government may increase spending in order to increase demand to reduce unemployment. Government spending also automatically rises during a recession as they have to spend more on unemployment benefits.
During booms, the government may decrease spending to decrease demand and reduce inflation.

Question 27

Explain Fiscal policy’s influence on Government expenditure

Answer 27

Fiscal policy is the decisions about government spending and taxes and it will depend on the priorities of the government.

Question 28

what are the 5 influences on net trade balance

Answer 28

1) Real income
2) Exchange rates
3) State of the world economy
4) Degree of protectionism
5) Non-price factors

Question 29

Explain Real income’s influence on net trade balance

Answer 29

When real income in the UK is high, there tends to be increased imports as people demand more goods and services and the UK is unable to meet their needs. This will mean that net trade decreases. However, if an increase in real income is due to export-led growth then net trade will increase.

Question 30

Explain Exchange rate’s influence on net trade balance

Answer 30

A strong pound (when the pound is worth a lot in comparison to
other countries) makes imports cheap and exports dear because it costs foreigners more to buy pounds with their local currency. As a result, imports will increase and exports will decrease so net trade will decrease. This depends on the elasticity of imports and exports. If imports are price elastic, a rise in price will cause a large fall in demand so the value of imports will fall.

Question 31

Explain State of the world’s economy’s influence on net trade balance

Answer 31

If the UK’s main export country is doing well, then UK exports are likely to rise and so net trade is likely to rise. The effect of the state of the world economy is dependent on which countries are doing well and the trade relationship the UK has with them.

Question 32

Explain Degree of protectionism’s influence on net trade balance

Answer 32

Protectionism is an attempt to prevent domestic
producers suffering from competition abroad. Tariffs, quotas and technical barriers are introduced which makes it harder for producers from abroad to sell their goods in the UK

Question 33

Explain Non-price factors’ influence on net trade balance

Answer 33

Two non-price factors which affect net trade are quality and design and marketing. If UK goods are of a higher quality and design, exports will be high as foreign demand for UK goods will increase and imports will decrease as people will buy the British goods instead of foreign goods. This means net trade will increase