1.2 Aggregate Demand

Question 1

What is aggregate demand?

Answer 1

Total demand for all goods and services in an economy at a given price level and time period.

Question 2

What is the aggregate demand formula?

Answer 2

AD = C + I + G + (X − M).

Question 3

What does C represent in the AD equation?

Answer 3

Household consumption expenditure.

Question 4

What does I represent in the AD equation?

Answer 4

Investment by firms in capital goods.

Question 5

What does G represent in the AD equation?

Answer 5

Government spending on goods and services.

Question 6

What does X − M represent in the AD equation?

Answer 6

Net exports (exports minus imports).

Question 7

Why does the aggregate demand curve slope downward?

Answer 7

Because of the wealth effect

Question 8

What is the wealth effect?

Answer 8

When a fall in the price level increases the real value of wealth

Question 9

What is the interest rate effect?

Answer 9

Lower price levels reduce interest rates

Question 10

What is the exchange rate effect?

Answer 10

Lower domestic prices increase export competitiveness and reduce imports.

Question 11

How does a fall in the price level affect consumption?

Answer 11

Real income rises so households can purchase more goods and services.

Question 12

Why might lower prices reduce interest rates?

Answer 12

Lower prices reduce demand for money for transactions

Question 13

How do lower interest rates affect investment?

Answer 13

They reduce borrowing costs

Question 14

How do lower interest rates affect consumption?

Answer 14

They reduce the incentive to save and encourage borrowing.

Question 15

How does a lower price level affect exports?

Answer 15

Domestic goods become relatively cheaper to foreign buyers.

Question 16

How does a lower price level affect imports?

Answer 16

Foreign goods become relatively more expensive.

Question 17

What causes a shift in aggregate demand?

Answer 17

Changes in consumption

Question 18

What is meant by an outward shift in AD?

Answer 18

An increase in total demand at every price level.

Question 19

What is meant by an inward shift in AD?

Answer 19

A decrease in total demand at every price level.

Question 20

How does consumer confidence affect aggregate demand?

Answer 20

Higher confidence increases consumption and shifts AD right.

Question 21

How does household wealth affect aggregate demand?

Answer 21

Higher wealth encourages greater spending.

Question 22

How do interest rates influence aggregate demand?

Answer 22

Lower interest rates increase consumption and investment.

Question 23

How do income tax cuts affect aggregate demand?

Answer 23

They increase disposable income and boost consumption.

Question 24

How does government spending influence aggregate demand?

Answer 24

Higher spending directly increases demand in the economy.

Question 25

How do business expectations influence investment?

Answer 25

Optimistic expectations increase investment spending.

Question 26

Why does investment often fluctuate more than consumption?

Answer 26

Because firms respond strongly to changes in economic expectations.

Question 27

How do exchange rate changes affect aggregate demand?

Answer 27

A weaker currency increases exports and reduces imports.

Question 28

Why does a depreciation of the currency increase AD?

Answer 28

Exports become cheaper and imports become more expensive.

Question 29

How does economic growth in other countries affect AD?

Answer 29

Stronger foreign growth increases demand for exports.

Question 30

How does protectionism affect aggregate demand?

Answer 30

Tariffs or quotas reduce imports and increase net exports.

Question 31

How can fiscal policy shift AD?

Answer 31

By changing taxation or government spending.

Question 32

How can monetary policy shift AD?

Answer 32

By altering interest rates and credit conditions.

Question 33

Why might an increase in savings reduce aggregate demand?

Answer 33

Because consumption falls.

Question 34

Why might rising household debt increase AD in the short run?

Answer 34

Borrowing allows higher spending.

Question 35

What role does population growth play in AD?

Answer 35

More people increase consumption demand.

Question 36

Why might inflation expectations increase consumption?

Answer 36

Households may spend now before prices rise further.

Question 37

Why might higher interest rates reduce AD?

Answer 37

They discourage borrowing and encourage saving.

Question 38

How do imports affect aggregate demand?

Answer 38

Higher imports reduce net exports and lower AD.

Question 39

What happens to AD during a recession?

Answer 39

Consumption and investment typically fall.

Question 40

What happens to AD during an economic boom?

Answer 40

Consumption

Question 41

Why is aggregate demand important for macroeconomic performance?

Answer 41

It determines overall spending