2.2. Aggregate Demand

What is Aggregate Demand (AD)?

Aggregate Demand (AD) is the total level of spending in the economy at any given price.

What are the components of Aggregate Demand?

The components of Aggregate Demand are Consumption (C), Investment (I), Government spending (G), and Net exports (X-M).

What percentage of Aggregate Demand does consumption make up?

Consumption makes up about 60% of Aggregate Demand.

What is the definition of investment in the context of Aggregate Demand?

Investment is spending by businesses on capital goods, such as new equipment and buildings.

How much of Aggregate Demand is typically comprised of net exports?

Net exports account for around 5% of Aggregate Demand.

What does the AD curve illustrate?

The AD curve shows the relationship between the price level and real GDP.

What is the income effect in relation to the AD curve?

The income effect states that as prices rise without a corresponding increase in income, real incomes fall, reducing demand.

What is the substitution effect concerning Aggregate Demand?

The substitution effect occurs when higher prices lead consumers to buy imported goods instead of more expensive domestic goods.

What is the real balance effect?

The real balance effect suggests that rising prices decrease the value of savings, prompting consumers to save more and spend less.

How does the interest rate effect influence Aggregate Demand?

The interest rate effect indicates that rising prices increase demand for money, leading to higher interest rates and reduced spending.

What signifies a movement along the AD curve?

A movement along the AD curve is caused by a change in prices.

What causes a shift in the AD curve?

A shift in the AD curve is caused by changes in any variable other than price.

What is the marginal propensity to consume (MPC)?

The MPC is the increase in consumption resulting from an increase in disposable income.

What does a higher MPC indicate about consumption patterns?

A higher MPC suggests that people tend to spend a larger portion of any increase in income.

What is the average propensity to consume (APC)?

The APC is the average amount spent on consumption out of total income.

How do savings relate to consumption?

When consumption increases, savings generally decrease, and vice versa.

What is the marginal propensity to save (MPS)?

The MPS is the portion of an increase in income that is saved.

What factors influence consumer spending?

Factors include interest rates, consumer confidence, wealth effects, distribution of income, tastes, and attitudes.

How do high interest rates affect consumer spending?

High interest rates raise costs of credit, reducing consumption as goods effectively become more expensive.

What impact does consumer confidence have on spending?

Higher consumer confidence leads to increased spending, while lower confidence can result in reduced consumption.

What is net trade?

Net trade is the difference between total exports and total imports.

What is the relationship between real income and net trade?

Higher real income often leads to increased imports, which can decrease net trade.

How do exchange rates affect net trade?

A strong currency makes imports cheaper and exports more expensive, often leading to decreased net trade.

What are animal spirits in economic context?

Animal spirits refer to the confidence level of businesses regarding investment and economic growth.

What is the effect of government spending on AD?

Government spending contributes significantly to Aggregate Demand.

What is fiscal policy?

Fiscal policy encompasses decisions regarding government spending and taxation.

How does the trade cycle influence government expenditure?

Governments increase spending during recessions to boost demand and decrease spending during booms to reduce inflation.

What is the relationship between interest rates and investment?

High interest rates increase borrowing costs, leading to lower levels of investment.

What is gross investment?

Gross investment is the total amount of investment carried out, ignoring depreciation.

What is net investment?

Net investment is gross investment minus the value of depreciation.

What can influence a firm's decision to invest?

Business expectations, economic growth, interest rates, and access to credit are significant influencing factors.

How do technological changes impact investment?

Technological improvements can increase profitability, encouraging more investment.

What is considered a highly regulated economy's effect on investment?

A highly regulated economy tends to see less investment due to increased costs and time.

What is meant by the term 'retained profit'?

Retained profit refers to profits kept by a firm rather than distributed to shareholders.

How does the age distribution of the population influence government expenditure?

An ageing population increases spending on pensions and healthcare, while a younger population demands more educational spending.

What are non-price factors affecting net trade?

Quality, design, and marketing of goods influence net trade in addition to price.

How do prices influence competitiveness in net trade?

Higher prices can make UK goods less competitive, leading to decreased exports and increased imports.

What role does distribution of income play in consumer spending?

Changes in income distribution can affect overall consumption levels, particularly if money shifts from rich to poor.

What is expected from lower interest rates in terms of consumer behavior?

Lower interest rates can lead consumers to delay purchases until credit becomes cheaper.

How does consumer's expectations about future prices influence current spending?

If consumers expect future price increases, they may buy more now, boosting current consumption.

What is the role of advertising in affecting net trade?

Effective marketing can increase demand for domestic goods, boosting exports and reducing imports.

Describe the significance of the trade balance.

A favorable trade balance (more exports than imports) increases Aggregate Demand, while a trade deficit can decrease it.