The document provides an overview of the recent performance and prospects of the UK economy. It discusses how investment expenditure fell in 2011 due to low business confidence from the eurozone crisis. Household consumption also declined as earnings growth was outpaced by inflation. Government austerity measures are expected to lower the budget deficit through spending cuts and tax increases. Export growth improved the trade balance but domestic demand remains weak, which could constrain import growth in 2012.

1. An introduction to
aggregate demand and
aggregate supply analysis
Quintin Brewer, a Chief Examiner, comments on a
question involving the use of aggregate demand
and aggregate supply analysis
The following extract outlines the recent performance and prospects for the UK
economy. Knowledge and understanding of the performance of the UK economy can
greatly enhance performance by candidates in examinations. The questions are aimed
at enabling AS Level students to secure a firm understanding of key terms and provide
an opportunity to apply aggregate demand and aggregate supply analysis to the
information provided.
The UK economy
Investment expenditure in 2011 fell by a little over 1%, reflecting the low level of business
confidence, which has been severely knocked by the ongoing crisis in the euro zone. In turn,
this has had a negative impact on domestic and foreign demand and so is unlikely to increase
by as much as previously predicted by most economists in 2012. Further, weak domestic
demand (discussed below) was a disincentive for firms to increase investment.
Household consumption expenditure also fell during 2011 not least because average earnings
rose by about 2.4% while the inflation rate was 4.3%. In 2012 it is likely that the rate of
inflation will fall rapidly so enabling real personal disposable income to increase slowly.
However, consumer confidence might continue to fall because concerns over job security are
increasing, associated with the continued rise in unemployment.
Government austerity measures are likely to result in a fall in net borrowing by the public
sector from around £130 billion in 2011/12 to £110 billion in 2012/13. These measures
include tax increases and significant reductions in public expenditure. These cuts apply to
both current expenditure and capital expenditure as well as on transfer payments. The
reduction in government investment might have significant implications for the productive
potential of the economy.
Export growth with imports remaining almost stable resulted in an improvement in the UK’s
trade balance towards the end of 2011. This was aided by the very significant fall in the value
Exam Board AS Unit A2 Unit
of sterling in 2008. The prospects for 2012 are that export growth should be continued but
probably at a slower rate while imports will be constrained because domestic demand will
AQA 2(3.2.2 4(3.4.2)
& 3.2.3) continue to be weak.
2(2.3.3
Edexcel & 2.3.4) 4(4.3.7)
OCR F582 F585
(a) Distinguish between aggregate demand and aggregate supply.
WEJC EC2(B) EC4(C) (b) Explain the factors influencing short run and long run aggregate supply.
CCEA AS(2)
(c) Explain what is meant by the term ‘investment’.
Int. Bacc. Standard 3.3
New 2011: 2 (2.2) (d) Examine two factors which have caused investment to fall in 2011.
Cambridge
Pre-U The National Economy (h) (e) Assess the economic effects of a reduction in investment. Illustrate your
answer with aggregate demand/aggregate supply diagram(s).
(f) In the light of the information provided, evaluate the factors which might
Key words influence consumption expenditure in the UK.
Aggregate demand and supply
Consumption expenditure (g) Analyse the likely effect of net trade on aggregate demand in the UK
Investment expenditure · Net trade in 2011 and 2012.
Economics Today · March 2012 15