Aggregate Demand (LS3)

Question 1

aggregate demand (AD)

Answer 1

the total demand in a whole economy for products at any given price

Question 2

AD formula

Answer 2

Consumption + investment + gov spending + (exports - imports)
AD= C+I+G+(X-M)

Question 3

Consumption

Answer 3

Spending by households + individuals on g+s
Makes up about 60% of AD
Biggest part of ad

Question 4

Investment

Answer 4

Spending by businesses on capital goods to increase output
Around 15-20% of AD
Investment is largely affected by interest rates

Question 5

Gov spending

Answer 5

Spending by gov on providing g+s, generally public and merit goods (stuff that society values and believes ppl should have)
Transfer payments (pensions, jobseekers allowances) aren’t included as money is just transferred from one group to another
Makes up around 18-20% of AD

Question 6

Net exports (X-M)

Answer 6

when imports are higher than exports this is a minus figure as more money leaves the uk than comes in
Exchange rates play key role in AD

Question 7

Exchange rates

Answer 7

Value of one currency expressed in terms of another

Question 8

SPICED

Answer 8

Strong
Pound
Imports
Cheaper
Exports
Dearer

Question 9

When the pound is stronger…

Answer 9

It benefits uk businesses that import
Hinders uk businesses that export

Question 10

WPIDEC

Answer 10

Weak
Pound
Imports
Dearer
Exports
Cheaper

Question 11

When the pound is weaker…

Answer 11

It benefits uk businesses that export
It hinders uk businesses that import

Question 12

the AD curve

Answer 12

Same as the demand curve for an individual market, but shows relationship between price level and real GDP instead of

Like demand curve the ad curve is downward sloping as a rise in prices causes a fall in real GDP

Question 13

Why AD curve slope downwards- income effect

Answer 13

Rise in prices (due to inflation) means ppl have lower real incomes so can’t buy as much, so less consumption

In other words ppls purchasing power has been reduced, until wages are increased to match inflation (this usually takes a while tho)

This would lead to a contraction in AD

Question 14

Why ad curve slopes downwards- trade/substitution effect

Answer 14

If prices in the UK rise, less foreigners will want to buy UK exports because they’re more expensive, and more UK residents will want to buy imported foreign goods because they are cheaper.
The rise in imports and fall of exports will decrease Net Exports (X - M) so AD will contract.

Question 15

Why ad curves slope downwards- interest rate effect

Answer 15

If prices increase, usually, so do interest rates… changes to interest rates are commonly used to meet inflation targets… if prices are too high, interest rates can be increased to slow down spending.
Higher interest rates lead to less AD because saving becomes more attractive, so
Consumption falls.
Investment also falls as higher interest rates makes borrowing more expensive. A lot of Investment is sourced through loaning money.

Question 16

Movement in AD curve only happens

Answer 16

movement along ad curve only happens when there is a change in the price level

Contraction in AD- movement up the AD curve, because price levels have increased, so demand drops

Question 17

Shift in ad curve

Answer 17

Happens when there is a change in any of the components of ad

Question 18

Disposable income

Answer 18

Money consumers have left to spend after taxes have been taken away and any state benefits have been added

Affected by government taxation
Higher tax= less disposable income

Question 19

Marginal propensity to consume formula

Answer 19

MPC= change in consumption/ change in disposable income

Question 20

Consumption function

Answer 20

The relationship between consumption and the factors which determine how much a person consumes

Question 21

What is the most importantdeterminant of consumption

Answer 21

Disposable jncome
As disposable income increases, so does consumption
How much consumption will rise by is determined by the MPC

Question 22

MPC

Answer 22

the proportion of an increase in someone’s income that is spent on consumer goods (consumption)

Question 23

Consumer goods

Answer 23

Products that are bought by households to satisfy their wants and needs directly

Question 24

Why is MPC an important concept

Answer 24

It helps to predict how changes in income will affect spending and aggregate demand in the economy

Question 25

If MPC is high…

Answer 25

A given increase in income will lead to a larger increase in consumption, which can stimulate economic growth

Question 26

The MPC can vary depending a variety of factors, including

Answer 26

A persons age Their income level The availability of credit Changes in tax and gov policies

Question 27

Why is MPC higher for lower income households

Answer 27

As they are more likely to spend a larger proportion of their income on necessities

Question 28

APC (average propensity to consume)

Answer 28

The average amount spent by households on consumption out of the total income (of a population)

Question 29

APC formula

Answer 29

Total consumption (C)/ total disposable income (Y)

Question 30

APC key points

Answer 30

Unlike MPC, APC looks at overall spending (not the change) compared to total income Poorer households usually have a higher APC as they spend most of what they earn Wealthier households often have a lower APC became they can save q bigger proportion of their income

Question 31

Why is investment affected by interest rates

Answer 31

If interest rates are high, for example, it becomes more expensive for firms to borrow money, so less investment takes place.

Question 32

Gross investment

Answer 32

the total money a business spends on new machines, buildings, equipment, etc.

Question 33

Depreciation (in equipment)

Answer 33

when old machines lose value because they wear out or become outdated.

Question 34

Net investment

Answer 34

gross investment minus depreciation (it shows the actual increase in productive capacity). In the UK, about 75% of gross investment is just replacing old stuff. So net investment (the real growth in capacity) is much smaller.

Question 35

7 influences on investment

Answer 35

Rate of economic growth Business expectations and confidence – ‘animal spirits’ Demand for exports Interest rates Influence of government and regulations Access to credit Technological change

Question 36

Investment influences: rate of economic growth

Answer 36

In a growing economy, firms invest more because higher demand means consumption is greater, so there are better returns on investment. If the economy is static, investment stays the same as firms only replace worn-out machinery (so little/no impact on net investment)

Question 37

Investment influences: animal spirits

Answer 37

When businesses are confident about the future growth of the business, investment increases as they prepare for the future. whether firms feel optimistic enough to invest. This phrase was coined by John Maynard Keynes, a famous British economist.

Question 38

Investment influences: demand for exports

Answer 38

If the world economy is booming, demand for exports is likely to increase. 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 to compete with these exporting firms.

Question 39

Investment influences: interest rates

Answer 39

Most investment is financed through borrowing, so higher interest rates make borrowing more expensive, and therefore less attractive For example, if interest rates are at 5%, firms need to be confident that the investment will return at least 5% (just to cover the cost of borrowing money to fund the initial investment)

Question 40

Investment influences: influence of gov and regulations

Answer 40

Governments can encourage investment by their own policy decisions. For example, they could offer tax reliefs or grants to businesses to try and encourage them to invest. Regulations also affects investment as a highly regulated economy tends to see less investment as regulation increases costs (e.g. attached plastic caps on bottles)

Question 41

Investment influences: access to credit

Answer 41

Availability of credit = how easy it is for firms to borrow money. The risk levels in the economy play a key role here… In recessions, it’s more difficult to access credit as banks are aware of the heightened risks of defaults (firms not being able to pay back the loan) If there is good access to credit, however, borrowing becomes easier so Investment is more likely

Question 42

Investment influences: technological change

Answer 42

Improvements in tech. will improve/speed up production… This will increase profitability for firms, meaning they’ll be more willing and able to invest Changes in tech. also means businesses will need to invest to keep up with the best technology to remain competitive

Question 43

Gov spending as a % of GDP

Answer 43

measures how much gov spends relative to tje size of economy Shows what share of national income is used for public services Higher % = larger public sector + more state involvement in economy Helps assess fiscal sustainability- too high % can lead to gov debt and inflation risks, too low % can limit growth and quality of public services

Question 44

Biggest revenue earner for uk gov

Answer 44

Income tax

Question 45

Net trade

Answer 45

Value of exports and imports, not quantity

Question 46

Factors influencing demand of exports

Answer 46

Price Exchange rates State of world economy Degree of protectionism Real income Non price factors

Question 47

Demand for exports- price

Answer 47

Affects how competitive they are in global markets If export prices rise, demand falls If prices fall, exports more attractive

Question 48

Demand for exports- exchange rates

Answer 48

If currency strengthens (appreciates) exports become more expensive If currency weakens (depreciates) exports become cheaper abroad

Question 49

Demand for exports- state of world economy

Answer 49

When global economic conditions are strong, other countries have higher incomes and spend more on imports, raising demand for exports In global recessions, demand for exports falls as countries cut back on spending

Question 50

Demand for exports- degree of protectionism

Answer 50

If other countries impose tariffs or quotas on imported goods, this makes exports more expensive and reduces demand. On the other hand, free trade agreements or lower trade barriers make it easier and cheaper to sell goods abroad, increasing export demand.

Question 51

Demand for exports- real income

Answer 51

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 all 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. Therefore, the effect of changes in real incomes is dependent on many factors.

Question 52

Demand for exports- quality + design + marketing

Answer 52

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. If UK goods are well marketed, people will have a stronger desire to buy British goods so exports will increase and imports will decrease, so net trade will increases. Strong quality/design and marketing will mean that British exports are likely to be more inelastic

Question 53

Why ad curves slope down- real balance effect

Answer 53

Rise in prices means money is worth less, so less financial security for ppl They will want to save more and reduce spending, so AD contracts

Question 54

Influences on consumption

Answer 54

Interest rates Consumer confidence Wealth effects Distribution of income Tastes and attitudes

Question 55

Influences on consumption- interest rates

Answer 55

Higher interest rates increase borrowing costs and encourage saving, leading to lower consumption. loan repayments become more expensive and saving becomes more attractive.

Question 56

Influences on consumption- wealth effect

Answer 56

Wealth effect- When an increase in household wealth (e.g., rising house prices or share values) leads to higher spending and reduced saving. Lower wealth (e.g., falling house or share prices) reduces confidence and decreases consumption.

Question 57

Influences on consumption- income distribution

Answer 57

If income shifts from the rich (low MPC) to the poor (high MPC), overall consumption increases.

Question 58

Influences on consumption - consumer confidence

Answer 58

When confidence is high, people spend more because they expect income to rise in the future; when low, they save more due to uncertainty. If people expect income to rise, they increase spending now; if they expect unemployment or recession, they reduce spending.

Question 59

Influences on consumption- tastes and attitudes

Answer 59

Modern consumers are driven by materialism and trends, increasing spending; if values shift toward saving or sustainability, consumption decreases.

Question 60

Influences on gov expenditure

Answer 60

Thr trade cycle Fiscal policy Age distribution of the population

Question 61

Influence on gov expenditure- trade cycle

Answer 61

In a recession, gov may increase spending to increase demand to reduce unemployment Gov spending automatically rises in a recession as they have to spend more on unemployment In economic booms the gov may decrease spending to decrease demand and reduce inflation

Question 62

Influence on gov expenditure - fiscal policy

Answer 62

Some gov spending is fixed from year to year But govs can vary what they spend each year Fiscal policy is the decisions about gov spending and taxes, depends on gov priorities

Question 63

Influence on gov expenditure - age distribution of the population

Answer 63

Aging pop= increased gov expenditure on pensions, social care etc Young pop leads to increased spending on education More dependants in the economy (young and old) = higher gov spending and tends to be