2.2 Aggregate Demand (AD) (Edexcel A Level Economics A)

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

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).

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.

An increase in direct taxes decreases disposable income.

True.

Consumption increases as disposable income increases.

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

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

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

Increased consumer confidence leads to increased consumption and decreased saving.

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

False.

Higher loan repayments lead to less consumption.

During a recession, consumption typically decreases and saving increases.

Rising property prices give consumers more confidence to borrow more money.

Increased borrowing leads to increased consumption.

Investment is the total spending on capital goods by firms.

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

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

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

Net investment is calculated using the formula

True.

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

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

There is mostly an inverse relationship between investment and interest rates.

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

Government subsidies can increase investment.

Higher business confidence typically leads to increased investment decisions.

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.

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

False.

Government expenditure does not include transfer payments.

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

When an economy is booming, tax revenue increases.

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

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

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

False.

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

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

False.

Government expenditure can happen on both local and national levels.

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

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

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

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

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.

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

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

A booming world economy typically increases demand for UK exports.

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

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.

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.

A slowing world economy typically decreases demand for UK exports.

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

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.