2.2: Aggregate Demand

• What is aggregate demand (AD)?

  Aggregate demand (AD) is the total demand for all goods/services in an economy at any given average price level.
• How is the value of aggregate demand often calculated?

  It is often calculated using the expenditure approach.
• What is the formula for calculating aggregate demand (AD)?

  AD = Consumption (C) + Investment (I) + Government spending (G) + (Exports - Imports) (X - M).
• What happens when aggregate demand (AD) increases?

  When AD increases, economic growth has occurred.
• What is consumption in the context of aggregate demand?

  Consumption is the total spending on goods/services by consumers (households) in an economy.
• What does investment refer to in aggregate demand?

  Investment is the total spending on capital goods by firms.
• What does government spending include in the context of aggregate demand?

  Government spending includes public sector salaries, payments for provision of merit and public goods, etc.
• What are net exports?

  Net exports are the difference between the revenue gained from selling goods/services abroad and the expenditure on goods/services from abroad.
• Who participates in exporting and importing goods/services?

  Individuals, firms, and governments export/import goods/services.
• What does the aggregate demand (AD) curve represent?

  The AD curve shows the relationship between the average price level and the total output in an economy.
• Why is the AD curve downward sloping?

  The AD curve is downward sloping due to the interest rate effect, wealth effect, and exchange rate effect.
• What is the interest rate effect in relation to the AD curve?

  At higher average price levels, there are likely to be higher interest rates, which reduce investment and incentivize households to save.
• How does the wealth effect influence aggregate demand?

  As the average price level increases, the purchasing power of households decreases, leading to a fall in aggregate demand.
• What is the exchange rate effect?

  As the average price level falls, interest rates are likely to fall too, lowering the exchange rate and making the economy's goods/services more attractive abroad, increasing exports.
• What happens to the AD curve when there is a change in the average price level?

  • A change in the average price level causes a movement along the AD curve.
  • An increase in average price level causes a contraction.
  • A decrease in average price level causes an expansion.
• What happens to the AD curve when there is a change in the determinants of aggregate demand?

  • A change in any of the determinants of aggregate demand results in a shift of the entire AD curve.
  • An increase in any determinant results in a rightward shift of the curve.
  • A decrease in any determinant results in a leftward shift of the curve.
• What is disposable income?

  Disposable income is the money that households have left from their salary/wages after paying taxes and receiving transfer payments/benefits.
• How does consumption relate to disposable income?

  Consumption increases as disposable income increases and decreases as disposable income decreases.
• What can disposable income be used for?

  Disposable income can either be saved or spent on goods/services (consumption).
• What happens to consumption when savings decrease?

  When savings decrease, consumption usually increases.
• What happens to consumption when savings increase?

  When savings increase, consumption usually decreases.
• What does the household savings ratio calculate?

  The household savings ratio calculates household savings as a proportion of household income.
• When is the household savings ratio often low?

  The household savings ratio is often low when an economy is booming and full of confidence.
• How do changes in interest rates affect consumer spending and savings?

  A change in interest rates will change the level of consumer spending and savings.
• What happens to savings when interest rates increase?

  If interest rates increase, there is a greater incentive to save.
• What is the relationship between saving and consumption when interest rates increase?

  More saving leads to less consumption when interest rates increase.
• What happens to monthly loan repayments when interest rates increase?

  If interest rates increase, the monthly repayment on any loan or mortgage increases.
• How do higher loan repayments affect consumption?

  Higher loan repayments lead to less consumption.
• What is the relationship between the strength of the economy and consumer confidence?

  The stronger the economy, the higher consumer confidence.
• How does consumer confidence affect consumption and saving?

  When consumer confidence is high, consumption increases and saving decreases.
• What happens to consumer confidence in a weakening or recessionary economy?

  In a weakening or recessionary economy, consumer confidence falls.
• How do consumers feel about their jobs during a recession?

  Consumers feel less secure in their jobs during a recession.
• What is the effect of decreased consumer confidence on consumption and saving?

  Consumption decreases and saving increases when consumer confidence falls.
• What happens to consumption when consumer wealth increases?

  If consumer wealth increases, then consumption usually increases.
• How do rising property prices or share prices affect consumer behavior?

  Rising property prices or share prices give consumers confidence to borrow more money.
• What is the relationship between increased borrowing and consumption?

  Increased borrowing leads to increased consumption.
• What are the factors that influence consumption?

  • Changes to wealth
  • Changes to consumer confidence
  • Changes to interest rates
• What influences government expenditure?

  The trade/business cycle and spending linked to achieving policy aims
• How does unemployment relate to the trade/business cycle?

  Unemployment decreases with a booming economy, leading to lower means-tested benefit payments
• What happens to tax revenue during a booming economy?

  Tax revenue increases and can be used to pay back government debt or increase expenditure