AL Unit 9: The Macroeconomy Flashcards
The multiplier
It measures the extent to which an increase in an injection into the circular flow brings about a magnified effect on the level of national income. An increase in injections will also affect the withdrawals. Each successive increase in AD will therefore become progressively less
Calculation of the multiplier
2-sector economy (households and firms): 1/MPS
3-sector economy (households, firms and the government): 1/MPS+MPT
4-sector economy (households, firms, governments and foreign trade): 1/MPS+MPT+MPM
Overall 1/marginal propensity to withdraw
Average propensity to consumer and save
The proportion of income spent on consumption can be measured by the average propensity to consume. This refers to the average proportion of income that is actually spent on goods and services. The proportion of income that is not spent is saved so can refer to the average propensity to save
Dissaving
Consumption may exceed income so needs to be financed by past savings
Paradox of thrift
Saving is generally regarded as good because people can buy in the future but it is also a withdrawal from the circular flow so could contribute to a fall in national income which is the paradox of thrift
Marginal propensity to consume and save
Consumption can also be measured by the marginal propensity to consume which is concerned with a change in income and the proportion of that extra income that is spent. The proportion of extra income not spent is saved so refers to the marginal propensity to save
Influences on conusmption
Main influence is the level of disposable income but also includes:
Distribution of income and wealth
Rate of interest
Availability of credit
Expectation about future economic prospects
Average and marginal propensity to tax and import
Will also be needed to calculate the multiplier in a 4-sector economy
National income determination with AD and income
The level of income in an economy is determined at the point where AD equals output. The economy is at equilibrium where AD crosses the 45 degree line at Ye
Changing AD effect on national income
A change in AD can have a greater final impact on the level of equilibrium national income than the initial change due to the multiplier. An initial injection into the circular flow stimulates the future rounds of spending. Will eventually lead to a bigger effect on output and employment than initially. The size of the multiplier = change in real GDP/ change in AD
Positive multiplier
When an initial increase in an injection or a decrease in a leakage leads to a greater final decrease in real GDP
Negative multiplier
When an initial decrease in an injection or an increase in a leakage leads to a greater final decrease in real GDP
Components and determinants of AD
AD is the total demand for and expenditure on all that is produced in an economy. AD = C+I+G+(X-M)
The consumption function
Shows the relationship between consumer spending and the factors affecting it. The main influence on consumption is the level of disposable income and the consumption function shows the relationship between income and consumption
Autonomous consumption
Consumption that is not related to income
Induced consumption
Consumption related to income. As extra income is gained, some of this will be spent
The savings function
Shows the relationship between saving and the factors affecting it
Autonomous saving
Savings that are not related to income
Induced saving
Savings related to income. As extra income is gained, some of this will be saved
The investment function
Investment is the capital expenditure by firms in an economy over a period of time. The investment function shows the relationship between investment spending and the factors affecting it
Influences on investment decisions
Rate of interest
Changes in technology
Productivity of labour
Cost of capital goods
Changes in consumer demand
Expectations about future economic prospects
Government policies
Autonomous investment
Refers to expenditure on capital investment that is not the result of any changes in the level of national income. An increase or decrease will be shown by an upward or downward shift of the AD curve
Induced investment
Refers to expenditure on capital equipment directly related to changes in income. It is an important part of the accelerator theory of investment
The accelerator
Based on the link between changes in the level of national income and changes in induced investment. It states that investment is a function of change in national income and it assumes a fixed capital:output ratio. Concerned not with the level of output but with the rate of change of output