Question

1. How does a change in the autonomous expenditure influence the AE curve curve? Use graph to support your answer (2.5 Marks) 2. What is the difference between financial capital, physical capital and human capital? (2.5 Marks) Question Two: (A1, C1) 1. Explain how change in the interest rate and inflation might affect saving and investment decision in the economy? (2.5 Marks) 2. What are the five main determinants of consumption spending? Which of these is the most important? (2.5 Marks)

Answer 1

1. The change in autonomous expenditure moves the AE curve in the parallel manner. Increase in autonomous expenditure will shift the AE curve upwards in a parallel manner.

2. Physical capital refers to the tangible assets of the firms such as machines, factories etc. which can be actually touched. Financial capital, on the other hand, implies the legal ownership of those assets. Financial capital is the sum of all assets minus the debt. It includes bonds, equity etc. Human capital implies knowledge, ideas, working skills, experience etc.

3. Savings are positively related with the interest rate. When more interest rate is there on the savings, people will save more. This is because benefit of saving rises.

On the other hand, when there are lesser interest rates on the loans, people will invest more because the cost of investing reduce.

Similarly, when there is inflation, people tend to consume less and save more. Due to more savings by people, aggregate demand reduces in the economy. Due to this, producers will be willing to invest less.

4. The important determinants of consumption spending are:

i. Wealth of the individuals: Wealthy individuals can afford to consume more.

ii. Income of the individual: People with higher incomes can consume more as compared to the people with lower incomes.

iii. Price level: When prices are less on an average, people tend to consume more.

iv. Age of the consumer: People in their middle ages tend to consume more because at this time, most individuals are at the peak of their income levels.

v. Tastes and preferences of the consumer: Cultural influences, society etc. Influence the tastes and preferences of the consumer and hence affect the consumption levels in the economy.

The most important determinant is the current income of the individual. Current income allows consumers to consume more or less with the other things remaining constant.