Macro- AD

Question 1

What is AD?

Answer 1

The total level of spending in the economy at any given price.

Question 2

What are the components of AD?

Answer 2

AD = C+I+G+(X-M) , consumption + investment + government spending + net exports

Question 3

C

What is consumption?

Answer 3

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

Question 4

What is Investment?

Answer 4

Investment is spending by businesses on capital goods e.g. stocks and work in progress; it makes up
about 15-20% of AD.

Question 5

What is government spending?

Answer 5

spending by the government on providing goods and
services, . This will
change year on year as governments decides how much they spend. Government spending tends to be around 18-20% of GDP.

Question 6

What is net export?

Answer 6

Net exports is exports minus imports: when imports are higher than exports this is a
minus figure as more money leaves the UK than comes in. This is the least significant part of AD at around 5%.

Question 7

What are the four reasons as to why an AD curve slopes?

Answer 7

A rise in price causes a fall in GDP because:
Income effect
Substitution effect
Real Balance effect
Interest Rate effect

Question 8

Explain the income effect as it relates to an AD curve?

Answer 8

A rise in prices will not be matched immediately to a rise in income so consumers will be able to afford less, leading to a contraction in demand.

Question 9

Explain the substitution effect as it relates to an AD curve?

Answer 9

If prices in the UK rise, less foreigners will want to buy exported UK goods and more Brits will want to buy imported goods as they are cheaper. This rise in imports and fall in exports will decrease net imports and so thus AD contracts.

Question 10

Explain the real balance effect as it related to the AD curve.

Answer 10

A rise in prices will mean hat the money people have saved will be worth less and offer less security which will ptompt people to save more money detracting from what would have otherwise been used in consumption through spending which leads to a contraction in AD.

Question 11

E

What is disposable income?

Answer 11

Y, income minus tax

Question 12

Explain the Interest rate effect as it relates to the AD curve.

Answer 12

A rise in prices means that businesses will have to pay their workers more and so the demand for money is higher. If supply remains the same, the “price of money” i.e. interest rates will increase. Which makes people save more rather than spend, leading to a contraction in AD.

Question 13

What is Marginal Propensity to Consume (MPC)?

Answer 13

How much an increase in income affects consumption.

Question 14

Who tends to have a higher MPC?

Answer 14

Poorer people tend to as they are more likely to spend much more of their increase in income than rich people who are more likely to save.

Question 15

What is the MPC?

Answer 15

change in consumption / change in income.

Question 16

How do interest rates influence consumer spending?

Answer 16

Most major expenditures are bought on credit so therefore the
interest rate will affect the cost of the good for consumers. If interest rates are high,
the price of the good will effectively be higher since more interest needs to be paid
back and this will lead to a reduction in consumption. High interest rates also
increase mortgage repayments so reduce consumption

Question 17

How does consumer confidence effect consumption?

Answer 17

If consumers are confident about the future, then they will continue or increase their spending. If they expect high levels of inflation in the future, they will buy now as it will be at a cheaper price,
so consumption will increase. If they expect a recession and fear possible unemployment, consumption will decrease as people may save more. Expectations about a change in the taxation level will affect consumption also.

Question 18

How does the wealth effect affect consumption?

Answer 18

The wealth effet is a change in consumption following a change in wealth. It is experienced when eal house prices rise and owners no have more wealth so they are confident that in case of financial difficulty they can borrow against the house leaing them to be able to spend less frugally.

Question 19

Difference between gross and net invetment

Answer 19

Gross investment is the amount of investment carried out and ignores the level of depreciation,
whilst net investment is gross investment minus the value of depreciation.

Question 20

How does the rate of econmic growth influence investment?

Answer 20

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. For example, buying a new machine would lead to more products being made, but if the economy
was declining these products wouldn’t be bought so there would be no or little return on the investment. On top of this, a growing economy needs more investment in order to cope with the higher levels of demand.

Question 21

How do ‘animal spirits’ influence consumer confidence?

Answer 21

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.

Question 22

How do interest rates influence investment?

Answer 22

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.