7.5 Demand-Determined Output Flashcards
Our macro model is based on three central concepts. What are they?
- Equilibrium National Income
- The Simple Multiplier
- Constant Prices and Demand-Determined Output
What is the equilibrium level of national income. What does its positioning say about the economy?
The equilibrium level of national income is the level at which desired aggregate expenditure equals actual national income . If actual national income exceeds desired expenditure, inventories are rising and so firms will eventually reduce production, causing national income to fall. If actual national income is less than desired expenditure, inventories will be falling and so firms will eventually increase production, causing national income to rise.
What is the simple multiplier? What does it measure?
The simple multiplier measures the change in equilibrium national income that results from a change in the autonomous part of desired aggregate expenditure.
The simple multiplier is equal to , where z is the marginal propensity to spend out of national income.
In the model of Chapter 6, in which there is no government and no foreign trade, z is simply the marginal propensity to consume out of disposable income.
In our expanded model that contains both government and foreign trade, z is reduced by the presence of net taxes and imports.
Review of the simple modifier with and without government.
Relationship between the assumption of constant price level and Demand Determined
Our model is so far constructed for a given price level—that is, the price level is assumed to be constant. This assumption of a given price level is related to another assumption that we have been making. We have been assuming that firms are able and willing to produce any amount of output that is demanded without requiring any change in prices. When this is true, national income depends only on how much is demanded—that is, national income is demand determined
What is the first situation in which we may expect national income to be demand determined?
First, when there are unemployed resources and firms have excess capacity, firms will often be prepared to provide whatever is demanded from them at unchanged prices. In contrast, if the economy’s resources are fully employed and firms have no excess capacity, increases in output may be possible only with higher unit costs, and these cost increases may lead to price increases.
What is the second situation in which we may expect national income to be demand determined?
The second situation occurs when firms are price setters. Readers who have studied some microeconomics will recognize this term. It means that the firm has the ability to influence the price of its product, either because it is large relative to the market or, more usually, because it sells a product that is differentiated to some extent from the products of its competitors.
How do price setting firms often respond to changes in demand?
Firms that are price setters often respond to changes in demand by altering their production and sales, at least initially, rather than by adjusting their prices. Only after some time has passed, and the change in demand has persisted, do such firms adjust their prices. This type of behaviour corresponds well to our short-run macro model in which changes in demand initially lead to changes in output (for a given price level).
What assumption does our simple model of national income assume?
Our simple model of national income determination assumes a constant price level. In this model, national income is demand determined.
When the MPC increases, atonomous spending will have more or less of an impact? What is the effect on the multiplier?
It will have more of an impact because the multiplier increases.
