AS-level Macroeconomics Topic 1.2: Aggregate Demand (AD)

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Questions and Answers

What is aggregate demand and what does it measure in an economy?

Aggregate demand is the total demand in the economy and it measures spending on goods and services by consumers, firms, the government and overseas consumers and firms.

What is the largest component of aggregate demand, and what percentage of GDP does it make up?

Consumer spending is the largest component of aggregate demand, making up just over 60% of GDP.

How does a decrease in interest rates by the Monetary Policy Committee influence consumer spending?

A decrease in interest rates by the Monetary Policy Committee increases consumer spending by making borrowing cheaper, reducing the incentive to save, and increasing the effective disposable income of households.

What is disposable income, and what is it used for?

<p>Disposable income is the amount of income consumers have left over after taxes and social security charges have been removed, and it is what consumers can choose to spend.</p> Signup and view all the answers

What are some sources of consumer income, according to the text?

<p>Consumer income might come from wages, savings, pensions, benefits, and investments, such as dividend payments.</p> Signup and view all the answers

What is a limitation of using interest rates to stimulate aggregate demand, according to the text?

<p>There are time lags between the change in interest rates and the rise in AD, so this is not suitable if a rise in AD is needed immediately.</p> Signup and view all the answers

What is the relationship between demand for exports and investment, and how does it affect firms' decisions?

<p>When demand for exports is high, firms are more likely to invest because they expect higher sales, leading to increased investment in capital goods.</p> Signup and view all the answers

How do changes in interest rates influence investment, and what are the implications for firms and consumers?

<p>A decrease in interest rates increases investment as the cost of borrowing decreases, while high interest rates discourage investment and may lead to a decrease in consumer spending.</p> Signup and view all the answers

What is the relationship between access to credit and investment, and how has it been affected by the financial crisis?

<p>Access to credit is essential for investment, and a lack of access, as seen during the financial crisis, can limit investment opportunities; firms may need to rely on retained profits instead.</p> Signup and view all the answers

How does the availability of funds in an economy impact investment, and what role do consumers play?

<p>The availability of funds, dependent on consumer saving, determines the amount of funds available for lending and investment.</p> Signup and view all the answers

What is the impact of corporation tax rates on investment, and how do changes in tax rates affect firms' decisions?

<p>Lower corporation tax rates encourage investment as firms retain more profits, while higher tax rates may discourage investment.</p> Signup and view all the answers

What is the relationship between government spending and investment, and what proportion of GDP does it account for?

<p>Government spending, which accounts for 18-20% of GDP, can influence investment indirectly by creating demand for goods and services.</p> Signup and view all the answers

What is the primary reason why transfer payments are not included in the calculation of aggregate demand?

<p>because no output is derived from them</p> Signup and view all the answers

How does the government's response to recessions impact the government deficit?

<p>it increases the government deficit</p> Signup and view all the answers

What is the term used to describe the stage of economic growth that the economy is in?

<p>trade cycle or business cycle</p> Signup and view all the answers

Why might governments reduce spending during periods of economic growth?

<p>because the economy does not need stimulating and fewer people will be claiming benefits</p> Signup and view all the answers

What is the primary goal of fiscal policy?

<p>to influence the economy</p> Signup and view all the answers

What types of goods might governments spend on as part of their fiscal policy?

<p>public goods and merit goods</p> Signup and view all the answers

What is the consequence of a decline in economic growth in one of the UK's export markets on the UK's exports?

<p>Exports will decrease as consumer spending in those economies will fall due to falling real incomes.</p> Signup and view all the answers

How does protectionism impact the trade deficit in the UK?

<p>Protectionism reduces the trade deficit by reducing imports, but may also lead to a decrease in exports due to retaliation.</p> Signup and view all the answers

What determines the competitiveness of a country's goods and services?

<p>Competitiveness is influenced by supply-side policies, innovation, quality, niche markets, labour costs, productivity, and infrastructure.</p> Signup and view all the answers

How does a decline in real income in export markets affect the demand for UK goods and services?

<p>A decline in real income reduces the demand for UK goods and services.</p> Signup and view all the answers

What is the impact of protectionism on UK exports?

<p>Protectionism may lead to a decrease in UK exports due to retaliation.</p> Signup and view all the answers

What determines the value of UK exports?

<p>The value of UK exports is determined by the price elasticity of demand.</p> Signup and view all the answers

How does fiscal policy influence the economy, and what is the impact of the UK's trade deficit on the value of Aggregate Demand (AD)?

<p>Fiscal policy is a demand-side policy that influences the level or composition of Aggregate Demand (AD). The UK's trade deficit reduces the value of AD, as exports minus imports results in a negative value.</p> Signup and view all the answers

What is the relationship between real income and the current account, and how does it affect the trade balance?

<p>During periods of economic growth, higher real incomes lead to increased spending, a larger deficit on the current account, and a wider trade deficit. Conversely, during economic decline, real incomes fall, and the current account improves.</p> Signup and view all the answers

How does a depreciation of the pound affect the current account trade deficit, and what conditions are necessary for it to have a significant impact?

<p>A depreciation of the pound makes exports cheaper and imports more expensive, narrowing the current account trade deficit. However, this depends on which currency the pound depreciates against, and the demand for UK exports must be price elastic.</p> Signup and view all the answers

What is the impact of changes in real income on the trade balance, and how does this relate to the current account?

<p>An increase in real income leads to a wider trade deficit, while a decrease in real income improves the trade balance and the current account.</p> Signup and view all the answers

How does the exchange rate affect the trade balance, and what are the implications for the current account?

<p>A depreciation of the pound improves the trade balance and the current account, as exports become cheaper and imports more expensive. However, this depends on the specific currencies involved and the elasticity of demand for UK exports.</p> Signup and view all the answers

What are the main influences on the (net) trade balance, and how do they relate to the current account?

<p>The main influences on the (net) trade balance are real income and exchange rates, which in turn affect the current account. Real income affects spending patterns, while exchange rates influence the competitiveness of UK exports.</p> Signup and view all the answers

What is the likely impact of an increase in demand for exports on firms' investment decisions?

<p>Firms will be more likely to invest in capital goods. (B)</p> Signup and view all the answers

What is the impact of high interest rates on consumer spending?

<p>It will discourage consumer spending. (B)</p> Signup and view all the answers

What is the role of access to credit in investment decisions?

<p>Access to credit encourages investment, especially after a financial crisis. (C)</p> Signup and view all the answers

How does the availability of funds in an economy affect investment?

<p>More available funds lead to higher investment. (B)</p> Signup and view all the answers

What is the impact of corporation tax rates on investment?

<p>Lower corporation tax rates encourage investment. (A)</p> Signup and view all the answers

What proportion of GDP does government spending account for?

<p>18-20% (B)</p> Signup and view all the answers

What is the implication of an increase in disposable income on consumer spending?

<p>Consumer spending is likely to increase. (C)</p> Signup and view all the answers

How does a decrease in interest rates affect the cost of debt?

<p>It reduces the cost of debt, such as mortgages. (C)</p> Signup and view all the answers

What is the impact of a lower interest rate on consumer spending in the short term?

<p>It has no immediate effect on consumer spending. (A)</p> Signup and view all the answers

Why is consumer spending the largest component of aggregate demand?

<p>Because it makes up just over 60% of GDP. (B)</p> Signup and view all the answers

What determines the level of consumer spending?

<p>The level of disposable income. (A)</p> Signup and view all the answers

What is the result of a cheaper borrowing environment on consumer spending?

<p>It reduces the cost of debt, leading to increased spending. (C)</p> Signup and view all the answers

What is the primary reason why governments might increase spending during recessions?

<p>To stimulate the economy and increase real output (D)</p> Signup and view all the answers

What is the likely outcome of a government increasing spending during a recession?

<p>An increase in the government deficit (B)</p> Signup and view all the answers

What is the relationship between government spending and the trade cycle?

<p>Government spending is directly related to the trade cycle (B)</p> Signup and view all the answers

What is the primary goal of fiscal policy, as described in the text?

<p>To influence the economy (C)</p> Signup and view all the answers

What is the likely outcome of a government reducing spending during a boom?

<p>A decrease in the government deficit (C)</p> Signup and view all the answers

What type of goods might governments spend on as part of their fiscal policy, according to the text?

<p>Public goods and merit goods (B)</p> Signup and view all the answers

What is the effect of a depreciation of the pound on the current account trade deficit?

<p>It narrows the deficit (C)</p> Signup and view all the answers

What is the relationship between real income and the current account?

<p>An increase in real income leads to a larger trade deficit (A)</p> Signup and view all the answers

What is the impact of economic growth on the trade deficit?

<p>It increases the trade deficit (A)</p> Signup and view all the answers

What is the effect of a depreciation of the pound against the dollar or euro on the current account trade deficit?

<p>It has a significant impact (D)</p> Signup and view all the answers

What is the effect of an increase in real income on imports and exports?

<p>It increases imports and decreases exports (B)</p> Signup and view all the answers

What is the relationship between the exchange rate and the trade balance?

<p>A depreciation of the pound improves the trade balance (A)</p> Signup and view all the answers

What is the consequence of a decline in economic growth in one of the UK's export markets on the UK's exports?

<p>Exports will decrease (C)</p> Signup and view all the answers

What is the effect of protectionism on the trade deficit in the UK?

<p>It will decrease the trade deficit (B)</p> Signup and view all the answers

What determines the competitiveness of a country's goods and services?

<p>A combination of factors, including innovation, quality, niche markets, labour costs, productivity, and infrastructure (B)</p> Signup and view all the answers

What is the impact of a decline in real income in export markets on the demand for UK goods and services?

<p>It will decrease the demand for UK goods and services (C)</p> Signup and view all the answers

What is the impact of protectionism on UK exports?

<p>It will decrease UK exports (A)</p> Signup and view all the answers

What determines the value of UK exports?

<p>The price and quantity of exports (B)</p> Signup and view all the answers

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Study Notes

Factors Affecting Investment

  • Higher demand leads to increased investment as firms expect higher sales.
  • Lower interest rates encourage investment as the cost of borrowing decreases.
  • Access to credit is crucial for investment; lack of credit can discourage investment.
  • Firms can use retained profits for investment if banks are unwilling to lend.
  • Corporation tax rates affect investment; lower taxes encourage investment.

Aggregate Demand

  • Aggregate demand is the total demand in the economy, consisting of:
    • Consumer spending (C)
    • Investment (I)
    • Government spending (G)
    • Exports minus imports (X-M)
  • Consumer spending is the largest component of AD, making up around 60% of GDP.

Influences on Consumer Spending

  • Interest rates: lower interest rates increase consumer spending.
  • Disposable income: higher disposable income leads to increased consumer spending.
  • Other influences on consumer spending include wages, savings, pensions, benefits, and investments.

Government Spending

  • Government spending is the third largest component of AD.
  • Influences on government expenditure include the trade cycle (business cycle).
  • During recessions, governments increase spending to stimulate the economy.
  • During periods of economic growth, governments may decrease spending and reduce the deficit.

Influences on Net Trade

  • Real income: during economic growth, consumers have higher incomes, leading to a larger trade deficit.
  • Exchange rates: depreciation of the pound can make exports cheaper, narrowing the trade deficit.
  • State of the world economy: economic decline in export markets reduces exports.
  • Degree of protectionism: protectionist measures can reduce imports, but may lead to retaliation and decreased exports.
  • Non-price factors: competitiveness of goods and services, innovation, and quality can increase exports.

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