57. Aggregate Demand: an introduction
1. Fill in the missing words
Aggregate demand is the ____________ demand for goods and services produced in the economy at any given
price level. The __________________ demand curve shows the relationship between the level of real expenditure
and the price level in the economy. The total level of expenditure in the economy at any given price level is the sum
of ____________________, investment, government spending and __________ minus __________. In the
circular flow of income, real expenditure equals real _________ equals real income and so the aggregate demand
curve plots each level of expenditure or output where the economy is in equilibrium at each price level. The price
level is the _______________ price of a basket of a goods and services in the economy. The aggregate demand
curve is downward sloping and so as the price level ___________, aggregate demand rises. Choose the words
from: imports, aggregate, falls, consumption, total, exports, output, average
2. Why does aggregate demand slope downwards? (Insert either increase/s or decrease/s)
2.1 Real balance effect: When the price level falls, the purchasing power of income increases and so the real value of
income _______________. Furthermore, a lower price level will also ______________ the value of a households’
wealth. Hence consumption _______________ and so aggregate demand _________________.
2.2 Net export effect: When the price level falls, UK prices will be relatively low compared to other countries
ceteris paribus. This will _________ the competitiveness of UK goods and services and so exports will
__________. Firms and households will also switch spending to UK goods and services and so imports must
__________ and hence aggregate demand _____________.
2.3 Interest rate effect: When the price level rises, firms and households will need to borrow more money to buy
the same number of goods and services. Assuming there is a fixed supply of money to be lent, an increase in demand
for money will _________ the rate of interest, or cost of borrowing. Consumption and investment are partly
financed by borrowing and so an ____________ in interest rates will _____________ consumption and
investment and so aggregate demand _____________.
3. Calculate the size of each of the following components of GDP for 2008.
2008 GDP at market prices: Expenditure type
£ million
Proportion of GDP
Household and NPISH final consumption expenditure
927 398
Total government expenditure
313 019
Total gross capital formation
246 435
Exports of goods and services
421 501
Less Imports of goods and services
- 459 899
Statistical discrepancy
- 2 341
GDP at market prices 2008
1 446 113
No need to calculate this.
100%
4. Match each question with one of the answers A - D.
Question
Answer
4.1
In 1975 inflation reached nearly 25%. What
would you expect to happen to the level of
aggregate demand?
A
It would rise.
4.2
Government spending is exogenous in the
aggregate demand model. What does this mean?
B
It would fall.
4.3
In July 2009, the Retail Price Index measure of
annual inflation was minus 1.4%. What would you
expect this to do the level of aggregate demand?
C
It would become flatter, or more elastic.
4.4
How would the slope of the aggregate demand
curve change if the interest rate effect was
strong?
D
It is determined outside of this model of the
economy and so independent of changes in
the price level.
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57. ANSWERS: Aggregate Demand: an introduction
1. Total, aggregate, consumption, exports, imports, output, average, falls
2.1 All increase/s
2.2 Increase, increase, decrease, increase.
2.3 Increase, increase, decrease, decrease.
3
Total consumption expenditure 64%
Total government expenditure 22%
Total gross capital formation 17%
Exports 29%
Imports 32%
4.1
B
4.2
D
4.3
A (ceteris paribus)
4.4
C (Monetarist view)
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