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Macroeconomic Theory (AS)

The units of aggregate demand (AD): Factors affecting consumption and investment, and the AD curve

  • 3 things to know
  • AS Units 1 and 2

Overview

How income, wealth, interest rates, expectations and tax drive consumption and investment, and what the AD curve shows and what shifts it.

What you need to know

Answer each one before you reveal it.

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Key term

What causes the AD curve to shift?

Key term

How does the level of income in the economy affect consumption?

Key term

How does household wealth affect consumption?

Questions from this subtopic

Each one with the model answer underneath.

  1. 1

    How does the level of income in the economy affect consumption?

    Model answer

    Higher income levels lead to higher consumption, as households have more money available to spend on goods and services.

  2. 2

    How does household wealth affect consumption?

    Model answer

    Higher levels of wealth increase consumption, as households feel more financially secure and are willing to spend more.

  3. 3

    Explain how higher interest rates affect consumption.

    Model answer

    Higher interest rates reduce consumption by increasing the cost of borrowing (making credit more expensive) and increasing the reward for saving (encouraging households to save rather than spend).

  4. 4

    Why might lower interest rates lead to increased consumption?

    Model answer

    Lower interest rates reduce the cost of borrowing and decrease the reward for saving, encouraging households to borrow and spend rather than save.

  5. 5

    How do consumer expectations about the future affect consumption?

    Model answer

    Positive expectations about future income and economic conditions encourage higher consumption, while pessimistic expectations lead households to reduce spending and save more.

  6. 6

    Explain how higher taxation affects consumption.

    Model answer

    Higher taxes reduce disposable income (income after tax), leaving households with less money available to spend, thus reducing consumption.

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AThe demand curve shifts to the left.
BExcess supply exists at the original price.
CPrice falls until a new equilibrium is reached.

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