Edexcel IAL Economics: Aggregate demand and its components (YEC11) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions cover section 2.3.2, Aggregate demand (AD), of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11), Issue 2, June 2018 (Unit 2, an International AS unit). All countries and figures are fictional. Work through the study guide first if a topic is new, and use the revision notes for the formulas. See also the course hub, the checklist and the free diagnostics.

Questions

1. Country A (illustrative, billions): consumption 480, investment 120, government expenditure 160, exports 150, imports 170. Calculate aggregate demand. [3]

2. Explain the difference between a movement along the AD curve and a shift of the AD curve. Give one cause of each. [4]

3. In Country B, households had disposable income of 25,000 and savings of 1,750 in Year 1. In Year 2 disposable income was 26,000 and savings were 2,340. Calculate (a) the savings ratio in each year and (b) the percentage change in consumption. [4]

4. Analyse how a rise in the savings ratio could affect aggregate demand and the economy. [6]

5. In Country C, gross investment was 90, depreciation was 55 and the opening capital stock was 1,100. Calculate net investment and the percentage change in the capital stock, and explain how net investment could be negative. [4]

6. A bakery chain is considering a project costing 400,000. It expects 44,000 of profit a year before tax and can borrow at 8%. (Ignore depreciation and the tax treatment of interest.)

(a) Calculate the return after tax if corporation tax is 30%. [2] (b) Calculate the return after tax if corporation tax is cut to 20%. [2] (c) Evaluate whether a cut in corporation tax will raise investment in the economy. [4]

7. Explain two influences on government expenditure. [4]

8. In Country F, exports are 800 and imports are 900 (millions). Foreign income rises 4% and the income elasticity of demand for Country A’s exports is 1.5. Home income rises 2% and the income elasticity of demand for imports is 2.0. Calculate the new level of exports, the new level of imports, and the change in the net trade balance. [6]

9. Country E sells 50,000 units of a manufactured good abroad at 200 each. A trading partner imposes a tariff that raises the price paid by its buyers by 15%. The price elasticity of demand for the good is 1.4 and Country E’s price received is unchanged. Calculate the change in Country E’s export revenue and analyse the likely effect on its AD. [6]

10. Country D’s currency falls from 2.50 to 2.30 foreign units per unit of home currency. Before the fall it exports 20,000 units priced 400 in home currency and imports 25,000 units priced 690 in foreign units. Price elasticity of demand for exports is 1.5. After the fall, imports are 24,000 units.

(a) Calculate the net trade balance before and after (home currency, millions). [5] (b) Evaluate whether the fall in the currency will raise AD. [7]

11. In Country G, consumption is 540, investment 130, government expenditure 190, exports 210 and imports 190. Evaluate the view that a fall in consumer confidence is a greater threat to AD than a fall in export demand. [9]

Answers

1. Net trade = 150 − 170 = −20 [1]. AD = 480 + 120 + 160 + (−20) [1] = 740 billion [1] [3] Examiner insight: Show the net trade figure as a negative number; adding imports instead of subtracting them is the usual slip, and a bare answer leaves nothing to reward if it is wrong.

2. Sliding along the curve happens when the price level alone changes [1], for example a rise in prices lowers real output demanded because of the interest rate effect [1]. A shift is caused by a change in any other influence on C, I, G or X−M at every price level [1], for example a fall in consumer confidence shifts AD left [1]. [4] Examiner insight: Give a cause for each, as asked; defining the two terms but naming no cause answers only half the question.

3. (a) Year 1: 1,750 ÷ 25,000 × 100 = 7.0% [1]. Year 2: 2,340 ÷ 26,000 × 100 = 9.0% [1] (b) Consumption: 25,000 − 1,750 = 23,250; 26,000 − 2,340 = 23,660 [1]. Change = 410 ÷ 23,250 × 100 = 1.76% [1] [4] Examiner insight: Consumption is disposable income minus savings, not the savings figure itself; check which quantity the percentage is of.

4. Households spend a smaller share of income, so C falls [1] and AD shifts left [1]. Firms’ sales fall, so output and employment may fall [1]. Banks hold more deposits and may lend more cheaply, which can raise I [1]. The effect is larger if spare capacity exists and the rise is sustained [1]. It is smaller if firms are pessimistic and will not borrow, so the extra saving is not turned into investment [1]. [6] Examiner insight: A chain from cause to AD to output earns more than a list of effects; a one-sided answer that ignores the lending link has no evaluation.

5. Net investment = 90 − 55 = 35 [1]. Change = 35 ÷ 1,100 × 100 = 3.18% [1]. Net investment is negative when gross investment is below depreciation [1], so the capital stock shrinks and productive capacity falls [1]. [4] Examiner insight: Use the opening stock as the base for the percentage; using the closing stock gives a different answer.

6. (a) After tax profit = 44,000 × 0.70 = 30,800 [1]; return = 30,800 ÷ 400,000 = 7.7% [1] (b) 44,000 × 0.80 = 35,200 [1]; return = 8.8% [1] (c) At 7.7% the return is below the 8% borrowing rate, so the project is not worth doing; at 8.8% it is [1]. So the cut can raise investment by lifting returns above the cost of funds [1]. But some firms would have invested anyway, and lower tax only helps profitable firms [1]. Business confidence, spare capacity and the cost to government revenue also matter, so the effect is uncertain [1]. [8] Examiner insight: Compare the calculated returns with the 8% rate in words; stating two percentages without a judgement leaves the conclusion unsupported.

7. Fiscal policy: governments choose spending levels to influence AD, such as raising G in a recession [1], which directly raises AD [1]. Level of economic activity: in a downturn, more unemployment raises benefit spending automatically [1], while higher incomes in a boom reduce it [1]. [4] Examiner insight: Two developed influences gain more than four named ones; each needs a reason, not just a label.

8. Exports rise 4 × 1.5 = 6% [1], so 800 × 1.06 = 848 [1]. Imports rise 2 × 2.0 = 4% [1], so 900 × 1.04 = 936 [1]. Balance before = 800 − 900 = −100 [1]; after = 848 − 936 = −88 [1]. The deficit narrows by 12. [6] Examiner insight: Use each country’s own income change for the right flow: foreign income for exports and home income for imports.

9. Quantity falls 15 × 1.4 = 21% [1], to 39,500 units. Revenue falls from 10.0 million to 39,500 × 200 = 7.9 million, a fall of 2.1 million [1]. Exports are a component of AD, so X−M falls and AD shifts left [1]. Output and jobs in export industries fall [1]. The impact depends on the share of exports in GDP [1], and on whether firms find new markets or the currency adjusts [1]. [6] Examiner insight: Link the calculation to AD rather than stopping at the revenue figure; the question asks for both.

10. (a) Before: exports 20,000 × 400 = 8.0 million [1]; import price 690 ÷ 2.50 = 276, so imports 25,000 × 276 = 6.9 million [1]; balance +1.1 million [1]. After: foreign price of exports falls 8%, so quantity rises 12% to 22,400 and revenue is 8.96 million [1]. Import price 690 ÷ 2.30 = 300, so 24,000 × 300 = 7.2 million; balance +1.76 million [1] (b) The balance improves by 0.66 million, so net trade and AD rise [1]. This is because export demand is elastic and imports fell [1]. Dearer imports raise costs for firms using imported materials, which may cut output [1]. Responses take time, so the short run may be worse [1]. A rise in AD only raises output if there is spare capacity [1]; otherwise it raises prices [1]. Retaliation or weak global demand may blunt the effect [1]. [12] Examiner insight: A conclusion that names the condition under which the fall helps, such as elastic demand, scores better than “it depends” with no reason.

11. AD = 540 + 130 + 190 + (210 − 190) = 880, so consumption is 61.4% of AD [1]. A 5% fall in C is 27, so AD falls 3.07%; a 10% fall in exports is 21, a fall of 2.39% [1]. Consumption is the largest component, so the same percentage shock in C has a larger effect [1]. Confidence shocks can spread across all households at once [1]. But exports are volatile, and a 10% shock may be more likely than a 5% shock [1]. Falling exports cut firms’ sales, which may cut I and C too [1]. Imports fall when income falls, partly offsetting the trade effect [1]. The judgement depends on how open the economy is: the more open it is, the greater the export threat [1]. Overall, for a large, closed economy the consumption threat is greater [1]. [9] Examiner insight: Support the comparison with numbers from the data, and close with a verdict and state what it depends on.

Where marks are usually lost

• Subtracting incorrectly in X−M, or ignoring the sign of the balance.
• Giving the savings ratio as a number of units instead of a percentage.
• Using closing rather than opening figures as the base for percentage changes.
• Listing influences with no explanation of how each affects AD.
• Stating that a currency fall always raises exports and improves the balance.
• Calling welfare benefits part of G.
• Concluding with “it depends” and no named factor.
• Giving numbers without units or saying what they refer to.

Next steps

• Review the revision notes and the study guide.
• Return to the course hub and the checklist.
• Take one of the free 10-minute diagnostics.
• Book a free trial class at /trial/.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics, Specification, Issue 2, June 2018, Pearson Education Limited. Section 2.3.2, Aggregate demand (AD).