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

About Edexcel International A Level Economics Aggregate Demand (AD)

Aggregate demand opens the macroeconomic analysis of Unit 2 in Edexcel International A Level Economics. You learn what makes up total spending in an economy and what causes each component to change. The AD curve slopes downwards against the price level, and shifts when any component changes for reasons other than the price level. This topic is essential for national income, the multiplier, economic growth and demand-side policy, and it returns in Unit 4 when you study trade, exchange rates and fiscal policy. Examiners like questions that ask you to analyse how a change, such as an interest rate rise or a currency depreciation, affects AD.

What you need to know

• Components of AD AD = C + I + G + (X - M). Consumption is usually the largest component. Net exports can be negative if imports exceed exports.
• Consumption Influenced by disposable income, interest rates, wealth effects (house and share prices), consumer confidence and the availability of credit. Know the marginal propensity to consume and save.
• Investment Spending by firms on capital goods. Influenced by interest rates, business confidence (animal spirits), the accelerator (investment depends on the rate of change of national income), government regulation and access to credit.
• Government spending Spending on public services and capital projects, but not transfer payments such as pensions and benefits, which are not payment for output. Depends on the government's fiscal stance and the economic cycle.
• Net exports X - M is influenced by real incomes at home and abroad, the exchange rate, relative inflation rates and non-price factors such as quality and protectionism.

Common mistakes in Aggregate Demand (AD)

• Including transfer payments in government spending. Benefits and pensions are not part of G in AD because they are not spending on goods and services.
• Shifting AD for a change in the price level. A change in the price level is a movement along the AD curve.
• Saying a depreciation reduces AD. A weaker currency makes exports cheaper and imports dearer, so net exports and AD usually rise.
• Treating investment as buying shares. In economics investment means spending on capital goods such as machinery and buildings.
• Ignoring confidence. Confidence often explains why lower interest rates fail to raise consumption and investment.

Try three Aggregate Demand (AD) exam-style questions