Chap. 5 - Macroeconomic Relationships Flashcards
What are the components of aggregate expenditures in a closed economy?
The components of aggregate expenditures in a closed economy are Consumption, Investment, and Government Spending.
What are the two things people do with their income?
Consume or Save it
Income = Consumption + Savings
What is the Consumption Function and give the equation.
The Consumption Function shows the relationship between consumption and disposable income.
C = a + b Yd
Yd = Disposable Income
In the Consumption Function: C = a + b Yd, explain each variable.
“a” is the intercept of the line and b is the slope. When Disposable Income (Yd - Income after taxes) is equal to zero you consume up to point a, also called “autonomous consumption,” or consumption that is independent of disposable income. b represents the expected increase in Consumption that results from a one unit increase in Disposable Income. b Illustrates the concept of Marginal Propensity to Consume (MPC)
What is the Savings Function and give the equation.
The Savings Function shows the relationship between savings and disposable income.
S = e + f Yd
In the Savings Function: S = e + f Yd explain each variable.
The intercept is e, the autonomous level of Savings. With savings, it is quite likely that “e” will be negative, which indicates that when Disposable Income is zero, Savings on average are negative. The slope of the savings function is “f,” and it represents the Marginal Propensity to Save
What is the Marginal Propensity to Consume and Marginal Propensity to Save?
The Marginal Propensity to Consume is the extra amount that people consume when they receive an extra dollar of income. If in one year your income goes up by $1,000, your consumption goes up by $900, and you savings go up by $100, then your MPC = .9 and your MPS = .1.
Give the equation for MPC
MPC = Change in Consumption/Change in Disposable Income = ∆C/∆Yd
Give the equation for MPS
MPS = Change in Savings/Change in Disposable Income = ∆S/∆Yd
Describe the graph for the Consumption Function and the Savings Function.
Consumption Function: the y axis is consumption and the x axis is Disposable Income. There is a 45 degree line and the Consumption Function line passes through it at some point.
Savings Function: the y axis is savings and the x axis is disposable income. Savings usually has a negative intercept and passes up through the disposable income axis at the same point where the consumption function passes through the 45 degree line.
If consumption is affected by something other than income how does that affect the function and give some examples.
Instead of a movement along the curve, it is a shift. Wealth, Expectations, and Consumer Indebtedness are some examples.
Investment only occurs when _____________?
Real capital is created.
Investment affects both ____ _____ aggregate demand and _______ _____ economic growth.
Short Run
Long Run
Why do firms invest?
Investment is guided by the profit motive—firms invest expecting a return on their investment. Before the investment takes place, firms only know their expected rate of return. Therefore, investment almost always involves some risk.
What has a big impact on making investment decisions?
The real rate of interest
Explain a real rate of interest and an investment scenario and explain the relationship between real rate of interest and investment.
The higher the real rate of interest, the fewer investment opportunities will be profitable. When the real rate of interest is at 8%, only those investments that have an expected rate of return higher than 8% will be undertaken. If the interest rate is 4%, all investments with an expected rate of return higher than 4% will be undertaken. There are more investments with an expected rate of return higher than 4% than there are with an expected rate of return higher than 8%, so there is more investment at a lower rather than a higher real rate of interest. This is a inverse relationship between the real rate of interest and the level of investment.
If investment is affected by something other than real interest rates how does that affect it and give some examples.
Instead of a movement along the curve it will shift the curve. Business Taxes, Technology, Stock of Capital Goods on Hand are a few examples
Explain the investment graph.
On the y axis there is real interest rates (r) and on the x axis there is investment. The investment curve is downward sloping showing the inverse relationship between investment demand and real interest rates.
