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List the components of AD and explain how each of these components is determined.
C + I + G + (X-M)
Consumption: The biggest influence on AD, changes in income, consumer confidence,
savings, availability of money/credit and the cost of it (rate of interest) are likely to
Investment: Firms investing in capital equipment such as machinery, tools, buildings.
Investment is determined by the rate of interest. Fall in the rate of interest will shift
AD to the right because borrowing will be cheaper. A rise in the rate of interest will
shift AD to the left. Positive expectations will increase investment.
Government Expenditure: Government spending on public/merit goods and services
provided to us by the government. Governments has decreased over the last 50 years
due to privatisation, and in aims to reduce taxation and their own borrowing.
Government spending into things such as hospitals will shift AD to the right.
Net Exports (Exports - Imports):
- The export business depends on the AD of the UK's trading partners, their
economies are strong and growing, demand for our exports should increase. If they
are in a recession, AD would shift to the left.
- If the £ falls in value against the $, then UK exports will be cheaper in the USA,
shifting AD to the right. If the £ increases in value, UK exports become expensive.
- If the economy is healthy, (growing and incomes rising), consumers will spend more
on imports, shifting AD to the left. If the value of the £ rises, then importing will be
cheaper and we will opt for importing foreign goods rather than buying domestic
Explain how AD affects the level of economic activity.
Economic activity is defined as how much buying and selling occurs over a period of
time. AD affects the level of economic activity because its determinants directly
affect economic decisions made daily. For example, if we as consumers believe the
economy is doing badly, we are less likely to purchase goods if we thought the
economy was doing well. This affects consumption, which is a determinant of AD,
and therefore shows that if AD increases, the level of economic activity has
increased also and vice versa.
Distinguish between short and long run aggregate supply and explain how each is
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Aggregate supply refers to the total value of goods/services produced in the
In the short run, it's assumed the capacity to produced is fixed which means output
can only be produced is there is spare productive capacity. Fixed costs cannot change
in the short run.
Aggregate supply in the long run is a period during which any input variable can
change such as rent.…read more
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Define inflation and distinguish between demand-pull and cost-push inflation
Inflation is described as the persistent rise in price of goods/services measured over
a period of time (annually) and as a percentage.
Demand pull inflation is inflation caused by an increase in aggregate demand. (An
increase in aggregate demand occurs when any of the components of aggregate
demand increase such as government spending or consumption).…read more
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Demand Side causes of unemployment:
- A deficiency of aggregate demand in the economy can cause cyclical
unemployment. There is not enough demand to employ the available factors of
production in the economy and so unemployment occurs as AD is below the full
employment level. The government would try to increase AD, by the MPC reducing
the rate of interest.
- When demand for labour falls because it is too expensive to employ workers.…read more