Aggregate Demand (AD) (Edexcel A Level Economics A): Exam Questions

Extract A

UK household consumption

Despite the slow growth in real household disposable incomes, consumer spending rose in 2017. Annual spending per person increased by £589, when compared with 2016. This may have reflected UK households’ delay in adjusting to the increase in inflation that was associated with the fall in the exchange rate of the British pound. The increase in consumption has also been driven by low interest rates. In 2017 UK house prices increased by an average of 5.1%. UK consumers have financed most of their spending by borrowing on credit cards in order to maintain their living standards. In 2017 borrowing on credit cards rose by 9.6%, the second-highest level since before the financial crisis. This has increased the Bank of England’s concerns about the sustainability of borrowing, given the slow growth in real incomes. The Bank has also indicated that the base interest rate was likely to rise faster than previously expected. More expensive credit could therefore constrain the ability of households to spend.

(Source: adapted from ‘Consumer Trends UK’, ONS, https://www.ons.gov.uk)

Figure 2: UK real household consumption, quarterly, £ billions, 1997 to 2018

Extract A

UK household consumption

Despite the slow growth in real household disposable incomes, consumer spending rose in 2017. Annual spending per person increased by £589, when compared with 2016. This may have reflected UK households’ delay in adjusting to the increase in inflation that was associated with the fall in the exchange rate of the British pound. The increase in consumption has also been driven by low interest rates. In 2017, UK house prices increased by an average of 5.1%. UK consumers have financed most of their spending by borrowing on credit cards in order to maintain their living standards.

In 2017 borrowing on credit cards rose by 9.6%, the second-highest level since before the financial crisis. This has increased the Bank of England’s concerns about the sustainability of borrowing, given the slow growth in real incomes. The Bank has also indicated that the base interest rate was likely to rise faster than previously expected. More expensive credit could therefore constrain the ability of households to spend.

(Source: adapted from ‘Consumer Trends UK’, ONS, https://www.ons.gov.uk)

Extract A

Rwandan tariffs on imports of used clothing

In a market in Kigali, Rwanda’s capital, an auction is under way. Sellers offer crumpled T-shirts and faded jeans; traders argue over the best picks. Everything is second-hand. A Tommy Hilfiger shirt sells for 5000 Rwandan francs ($5.82); a plain one for a tenth of that. Afterwards, a trader sorts through the purchases he will resell in his home village. The logos hint at their previous lives: Kent State University, a rotary club in Pennsylvania, Number One Dad. These auctions were once twice as busy, but in 2016 Rwanda’s government increased import tariffs on a kilo of used clothes from $0.20 to $2.50. Now many traders struggle to make a profit.

The traders are not the only ones who are unhappy. Exporters in the US claim the tariffs are costing jobs there. In March, the US President warned that he would suspend Rwanda’s tariff-free access to US markets for its clothing exports after 60 days if it did not remove the tariff. Globally, about $4 billion of used clothes crossed borders in 2016. The share from China and South Korea is growing, but 70% still come from Europe and North America. Many go to Asia and eastern Europe, but Africa remains the largest market. The trade enables poor people to afford clothes and creates retail jobs.

However, governments worry that the trade undercuts their own clothing manufacturers. Second-hand imports of clothing now dominate African markets. Researchers at the Overseas Development Institute, a British think-tank, estimate that Tanzania imports 540 million used items of clothing and 180 million new ones each year, while producing fewer than 20 million itself. African manufacturing is weak for many reasons, from ineffective privatisations to collapsing infrastructure.

But second-hand clothing imports are a major factor: it is estimated that they accounted for half of the fall in employment in the African clothing industry between 1981 and 2000. For example, a clothing factory in Kigali is operating at only 40% of capacity and employs 600 workers, down from 1100 in the 1990s. It is hard to compete, says Ritesh Patel, its manager, when a used imported T-shirt sells for the price of a bottle of water. Instead, the company specialises in uniforms for police, soldiers and security guards, which cannot be bought second-hand. The threatened suspension of tariff-free access to the US market would hurt Rwanda, but not very much.

Last year Rwanda sold just $1.5 million of clothing to the US. Nor, with about 12 million people, is Rwanda a big market for US exports.

(Source adapted from: https://www.economist.com)

Annual percentage change in average UK house prices

(Source: adapted from https://www.nationwide.co.uk)

Bank of England base interest rate, 2016–2020

(Source: adapted from https://www.bankofengland.co.uk)

In September 2022 the Bank of England increased the base interest rate from 1.75% to 2.25%.

(Source: adapted from https://www.bankofengland.co.uk)

Savings often provide the funds for investment. The UK's household savings ratio fell from 9.3% in 2015-16 to 5.3% in 2019-20. However, it surged to 16.9% in over the year 2020-21 as a result of the significant economic disruption caused by the global pandemic. 

Against a backdrop of tightening monetary policy and slow economic growth, business investment had risen by 3.4% in 2023, which was stronger than expected. 

Extract C
What next for the high street?

A high street is typically found in all UK towns and cities. Shops normally encountered in a typical UK high street can include successful small firms such as independent food retailers, cafés, nail and beauty salons, restaurants and charity shops. They differ from out-of-town shopping centres by being more diverse, family-run and offering local or personalised services. Customers are often very loyal. However, the high street may often have limited access by car or expensive parking facilities.

The rise of online retailers such as Amazon and eBay have placed huge pressures on UK high streets, with many well-known shops – and even successful retail chains – forced to close due to lost business. Many high-street firms cannot compete on price with online retailers who – because they frequently have very low fixed costs, can significantly undercut the high-street shops on price. Even before online shopping, competition was eroding high street activity, with out-of-town retail parks that were not necessarily cheaper but provided a larger range of shops and offered plentiful parking. They offer a shopping experience that other retailing cannot match – pleasant, safe pedestrian shopping, a clean environment, fun activities for children, and spend-the-day-there potential.

While the list of retail and leisure failures might suggest that the high street does not have a future, some analysts argue the opposite. Many believe that the high street is ideally placed to reinvent itself in response to the structural shift in working and shopping patterns that has resulted from the global health crisis 2020–22. The perceived weaknesses of the high street model – its fragmented ownership, lack of centralised coordination, and high vacancy rates – become strengths as they lower the barriers to entry for new concepts and operators.

They also enable risk-taking and innovation that will ultimately lead to a more flourishing and diverse environment on our local high streets. It should be possible for small firms to flourish even when staff shortages are pushing up wages in the high street, and house price falls damage consumer confidence and spending on perceived luxuries.

(Source: adapted from https://www.designingbuildings.co.uk/ and https://www2.deloitte. com)

Extract D

UK house prices may fall up to 20%

Turmoil on the UK financial markets has prompted analysts to predict that house prices could fall dramatically, and many lenders in the mortgage sector are withdrawing deals. People coming to the end of their fixed-rate mortgages are seeing rises from 2% to over 5.5%, with increases in the cost of borrowing of over £5200 a year by 2024 for the average mortgage in the UK. Many people think UK house prices will never fall, but analysts say the fall could be between 10% and 20%.

One mortgage lender said that a lack of housing supply will not keep house prices up when mortgage interest rates are somewhere between 5% and 7%. He claimed that ‘the decade-long property bubble is about to burst […] It’s a buyer’s market now’. The greatest impact will be seen in the southeast of England.

(Source: adapted from https://www.theguardian.com)

Extract E
UK job vacancies hit record 1.1 million as labour shortages increase

The ratio of jobless people to vacancies is 1.45 to 1, lower than at any point in the last 40 years. Social care for example, has 300,000 current unfilled posts. ‘Today’s figures show that labour shortages are now affecting the whole economy,’ said one analyst. ‘There are almost a million people fewer in the labour market, largely due to younger people staying in education and older people dropping out of the workforce.’

The inactivity rate is 21.1%, and many people are not returning to work after the global health crisis. ‘People seeking work do not have the skills or availability that employers need,’ said Kitty Ussher, chief economist at the Institute of Directors. Firms offering higher wages do not solve the issue.

(Source: adapted from https://www.ft.com/content/463f4fbd