2.2 - Aggregate demand (AD) - Economics A-level - Edexcel

Household consumption (C) accounts for ____ of AD

60%

Government spending (G) accounts for ____ of AD

25%

Investment (I) accounts for ____ of AD

15%

Net exports (X-M) accounts for ____ of AD

1%

Why is AD drawn as a downard slope? (name 3 reasons)

The real balance effect, investment, interest rate effect

What is the real balance effect?

As prices rise, more money is needed to get the same amount of goods

What is the interest rate effect?

If prices are high consumers will borrow more, as there is a fixed supply of money interest rates go up and rise in interest rate makes spending fall

What is the investment effect

higher interest rates = less profitable investments therefore number of investments fall

A change in the average price level will cause a ______ ____ the AD curve

movement along

A change in the value of the components of AD will cause a _____ of the curve

shift

What is disposable income?

The income that an individual receives after having paid any direct taxes and received any transfer payments/benefits

Generally as consumers save more they _____ ____

spend less

What is the (household) savings ratio?

It provides an idea of the average extent of saving for all households in the economy

How is the household savings ratio calculated?

As the percentage of disposable income that is saved

Do a rise in interest rates increase or decrease the incentive to save?

They increase the incentive, consumers subsitute spending for saving

Why are people more likely to save/less spend less? (2 reasons)

Return on savings increases, cost of buying on credit increases

How would the rise of interest rates effect the housing market?

May lead to a fall in average house prices as demand for houses falls because of the increased cost of taking out a mortgage - negative wealth effect

How does consumer confidence influence consumption?

If consumers aren’t confident in spending their money e.g. they are worried about losing a job, they will spend less - consumption may decrease

How does the wealth effect affect consumption?

actual changes in the economy can cause real spending increases (or decreases) - people may decide to trade in their increased wealth or it may just boost confidence

What is gross investment?

It is the total level of expenditure by firms on capital equipment before depreciation is taken into account

What is net investment?

Net investment accounts for the deprecation of capital (Net investment = Gross investment - capital depreciation)

Name 3 influences on levels of investment

Interest rates, availability of credit, business confidence

How do interest rates effect investment?

Some capital spending is financed by borrowing e.g. Loans - only few projects will be viable if cost of credit is high

How does availability of credit affect investment?

Banks may not be willing to lend to firms (‘credit crunch’)

Define the term ‘animal spiritis’

where entrepeneurs, encouraged by a rising market, tended to take too many risks

How does business confidence affect investment?

When animal spirits are strong, invetment is sufficient to maintain AD and vice versa (lack of investment can cause the economy to lapse into a depression)

Name both types of Government spending

Automatic and discretionary

What’s automatic spending?

Government spending which is non-discretionary and influenced by the business cycle e.g. JSA rises in a recession

What is discretionary spending?

The spending that the government may choose to change as part of its fiscal policy

Government spending is affected by the _____ cycle

trade