Aggregate Demand

Question 1

Definition of Aggregate Demand:

Answer 1

the total planned spending on real output produced within the economy

Question 2

Equation for AD:

Answer 2

AD=C+I+G+X-M

Question 3

What is AD=C+I+G+X-M?

Answer 3

Aggregate demand= consumption + investment + government spending + exports- imports

Question 4

What causes a fall in AD?

Answer 4

• Cut in government spending
• Higher interest rate
• Decline in household wealth (buyer discretionary income decrease)
• Increase in house price
• Fall in exports

Question 5

What causes an increase in AD?

Answer 5

• Expansion of supply credit
• Lower interest rates
• Increase in house price (owner wealth increase)
• Cuts in direct and indirect taxes
• Depreciation of the exchange rate
  - £ down- uk export cheaper: x^
  - Foreign import expensive: m down

Question 6

What overall causes a change in AD:

Answer 6

• Changes to monetary policy
• Changes to government fiscal policy
• Business and government confidence
• External shocks

Question 7

What is aggregate consumption:

Answer 7

Spending by all the households in the economy on consumer goods and services

Question 8

Factors determining consumption:

Answer 8

• Interest rate
• Current level of income
• Expected future income
• Wealth
• Levels of personal debt
• Consumer confidence
• Distribution of income
• Expectation of future inflation

Question 9

What is saving and when does it occur?

Answer 9

Its household disposable income that is not spent. Occurs when people decide to postpone their consumption until a future time

Question 10

Factors affecting saving?

Answer 10

• Real interest rate
• Price expectations
• Availability of credit
• Unemployment/ Job security
• Consumer confidence/Expectations/Uncertainty
• Taxation on savings
• Trust in savings institutions
• Need to pay back debt

Question 11

What is investment?

Answer 11

Planned demand for capital goods which include both physical capital and human capital

Question 12

Difference between saving and investment:

Answer 12

Saving is income that is not spent on consumption. Savings and consumption decisions are made by households
Investment is spending by firms on capital goods such as machines and equipment. Investment decisions are made by firms

Question 13

Factors affecting investment:

Answer 13

• Expected future sales revenue
• Expected future costs of production
• Expected future profit
• Relative prices of capital and labour
• Nature of technical progress
• Supply of investment funds
• Government policies

Question 14

What is the accelerator theory?

Answer 14

Investment levels are related to the rate of change of GDP.

Assumption: firms wish to keep the capital output ratio fixed

Question 15

When will the accelerator effect be high?

Answer 15

• Rate of change of consumer income and spending is strongly positive
• Amount of spare productive capacity for businesses is low
• Available supply of investment funds is high

Question 16

What is the negative accelerator effect?

Answer 16

When the rate of growth of demand in an industry slows the net investment spending by businesses often fall

Question 17

What is government spending?

Answer 17

Spending on state-provided goods and services including public goods and merit goods

Question 18

What is net trade balance?

Answer 18

Measures the value of exported goods and services minus the value of imported products

Question 19

What impact does net export have on AD ?

Answer 19

A trade surplus means X>M- AD will increase
A trade deficit means M>X- AD will fall
If X=M then trade balance is zero, external trade will have a neutral effect on AD

Question 20

Factors of net export:

Answer 20

• UK productivity
• Exhange rates
• Economic growth in other countries
• Extent of free trade

Question 21

What is a withdrawal/ injection in the AD equation?

Answer 21

C: flow between households and firms, impacted by savings and taxes
I: Injection 
G:Injection
X:Injection 
M: Withdrawal

Question 22

How do you calculate the value of the multiplier?

Answer 22

Initial change in injections/ Change in national income

Question 23

What will lead to a negative multiplier and therefore a fall in AD?

Answer 23

Cuts in spending and increases in taxes

Question 24

Factors affecting the multiplier effect:

Answer 24

• Interest rates
• Tax rates
• Imports
• Spare capacity