2.2 Aggregate Demand

What is aggregate demand (AD)?

Aggregate demand is the total demand for all goods and services in an economy at any given average price level

State the formula for aggregate demand.

AD = C + I + G + (X - M)

True or false?

An increase in AD indicates economic growth

True

An increase in AD indicates economic growth.

Define the term consumption.

Consumption is the total spending on goods/services by consumers (households) in an economy

What does investment mean in the context of AD?

Investment is the total spending on capital goods by firms

What is government spending in the context of AD?

Government spending is the total spending by the government in the economy, excluding transfer payments

Define the term net exports

Net exports are the difference between the revenue gained from selling goods and services abroad and the expenditure on goods and services from abroad

What is the approximate percentage of consumption in UK's AD?

60%

True or false?

The AD curve is upward sloping

False.

The AD curve is downward sloping.

What are the three reasons for the downward slope of the AD curve?

The three reasons are:

• the interest rate effect

• the wealth effect

• the exchange rate effect

What causes a movement along the AD curve?

A movement along the AD curve is caused by a change in the average price level in an economy

What causes a shift of the entire AD curve?

A shift of the entire AD curve is caused by a change in any of the components of aggregate demand: C+I+G+(X-M)

What is disposable income?

Disposable income is the money that households have left from their salary or wages after they have paid their direct taxes and have received any transfer payments or benefits

How does an increase in direct taxes affect disposable income?

An increase in direct taxes decreases disposable income

True or false?

Consumption increases as disposable income increases

True.

Consumption increases as disposable income increases

What is the relationship between savings and consumption?

When savings decrease, consumption usually increases, and vice versa

Define the household savings ratio

The household savings ratio calculates household savings as a proportion of household income

How do interest rates affect consumer spending?

If interest rates increase, there is a greater incentive to save and a lower incentive to borrow, leading to less consumption

What is the effect of increased consumer confidence on consumption?

Increased consumer confidence leads to increased consumption and decreased saving

How does an increase in consumer wealth affect consumption?

If consumer wealth increases, then consumption usually increases. This is called the positive wealth effect.

True or false?

Higher loan repayments lead to more consumption

False.

Higher loan repayments lead to less consumption

What happens to consumption during a recession?

During a recession, consumption typically decreases and saving increases

How do rising property prices affect consumer borrowing?

Rising property prices give consumers more confidence to borrow more money

What is the effect of increased borrowing on consumption?

Increased borrowing leads to increased consumption

What is investment in the context of AD?

Investment is the total spending on capital goods by firms

How does investment affect economic growth?

Investment helps to increase the capacity of an economy, leading to increased potential economic growth

Define depreciation

Depreciation is the decrease in monetary value of a capital good (asset) over time

What is gross investment?

Gross investment is the total amount of spending on capital goods, including replacing old capital goods and purchasing new ones

How is net investment calculated?

Net investment = Gross investment - Depreciation

True or false?

Net investment provides a better indication of new production possibilities

True.

Net investment provides a better indication of new production possibilities created through investment by firms

How does economic growth affect investment decisions?

Increasing economic growth sends a signal that higher output will generate higher profits, encouraging investment.

What is the relationship between interest rates and investment?

There is mostly an inverse relationship between investment and interest rate

How does demand for exports affect investment?

If demand for exports increases, firms will likely increase investment to meet the global demand

What is the effect of government subsidies on investment?

Government subsidies can increase investment

How does business confidence affect investment decisions?

Higher business confidence typically leads to increased investment decisions

What are Keynes' animal spirits in relation to investment?

• Keynes' animal spirits refer to the idea that firms are irrational, exhibiting too much optimism in good times and taking too many risks. This leads to increased investment and economic activity, boosting AD

What is government expenditure in AD?

Government expenditure is the total spending by the government in the economy

True or false?

Government expenditure includes transfer payments.

False.

Government expenditure does not include transfer payments

How does unemployment affect government expenditure during a boom?

During a boom unemployment falls, leading to lower levels of means-tested benefit payments

What happens to tax revenue when an economy is booming?

When an economy is booming, tax revenue increases

How can a government use increased tax revenue?

Increased tax revenue can be used to pay back government debt or increase expenditure on public/merit goods

What is fiscal policy?

Fiscal policy is the government's use of spending and taxation to influence the economy

How often is fiscal policy set?

Fiscal policy is set once a year and announced during the presentation of the government's budget

True or false?

Government expenditure is independent of policy aims

False.

Government expenditure is directly related to the government's macro-economic objectives and policy aims

How do policy aims influence government expenditure?

Policy aims directly influence government expenditure, as spending is allocated to achieve specific macro-economic objectives

True or False?

Government expenditure is always incurred at the national level?

alse.

Government expenditure can happen on both local and national levels

How does the trade cycle influence government expenditure?

The trade cycle influences government expenditure through changes in unemployment levels and tax revenue

What is an example of policy-driven government expenditure?

An example of policy-driven government expenditure is increased spending on education to improve a country's numeracy and literacy skills

What is the net trade balance?

The net trade balance is the difference between the value of exports and imports (X-M)

How does an increase in UK real income affect the trade balance?

An increase in UK real income typically weakens the trade balance as consumers purchase more imports generating an increase in money outflows

True or false?

An increase in real income abroad strengthens the UK trade balance

True.

An increase in real income abroad strengthens the UK trade balance as overseas consumers purchase more UK products, increasing the value of UK exports

What is the effect of a country's currency appreciation on its exports?

Currency appreciation makes exports more expensive in foreign currency terms, leading to a decrease in the value of exports

How does a country's currency depreciation affect its imports?

Currency depreciation makes imports more expensive in the country's own currency terms, leading to a decrease in the value of imports

What is the impact of a booming world economy on UK exports?

A booming world economy typically increases demand for UK exports

How does the use of increased protectionism by a country affect its trade balance?

Increased protectionism typically strengthens the trade balance by decreasing demand for imports

What is the Marshall-Lerner condition?

The Marshall-Lerner condition states a currency depreciation will improve the net trade balance only if the sum of the price elasticities of demand for exports and imports is greater than one. Demand must therefore be price elastic

True or false?

The J-curve suggests an immediate improvement in trade balance after currency devaluation

False.

The J curve suggests that the trade balance worsens in the short term after currency devaluation before improving in the medium to long term

How does a slowing world economy affect UK exports?

A slowing world economy typically decreases demand for UK exports

What happens to a country's trade balance when protectionism decreases?

When protectionism decreases, the trade balance typically weakens as demand for imports increases

How does the price elasticity of demand for exports and imports affect the trade balance?

The price elasticity of demand for exports and imports influences the extent to which the prices of exports and imports, affected by exchange rate changes, impact the quantities of exports and imports demanded