Chapter 11 Flashcards
Marginal propensity to consume (MPC)
The increase in consumer spending when disposable income rises by $1
∆ Consumer spending
∆ Disposable income
*usually between 0-1 because consumers dont spend all of an additional dollar
Marginal propensity to save (MPS)
The increase in household savings when disposable income raises by $1
1 -MPC
1 - ∆ consumer spending
∆ disposable income
Total increase in real GDP from a $100 billion rise in I
= 1
1- MPC X 100
Autonomous change in aggregate spending
An initial change in the desired level of spending by firms, households, or government at a given level of real GDP
∆Y = 1
1- MPC X100
Multiplier definition
The ratio of the total change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change
Multiplier formula
Multiplier = ∆Y = 1
∆AAS 1- MPC
automatic stabilizers
Taxes and some government programs act as automatic stabilizers, reducing the size of the multiplier
Consumption function definition
An equation showing how an individual household’s consumer spending varies with the household’s current disposable income
Consumption function equation
c = a + MPC x yd
Slow of consumption function
= rise over run
= ∆c/∆yd
= MPC
Aggregate consumption function definition
The relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending
Aggregate consumption function formula
C = A + MPC x YD
Permanent income hypothesis
Consumer spending ultimately depends mainly on the income people expect to have over the long term rather than on their current income
Life-cycle hypothesis
Consumers plan their spending over a lifetime, not just in response to their current disposable income
econometrics
the use of statistical techniques to fit economic models to empirical data
Principal factors of investment spending
interest rate
expected future level of real GDP
current level of production capacity
Planned investment spending
the investment spending businesses plan to undertake during a given period
Interest rates have biggest effect on what kind of investment spending?
residential construction
higher interest rate leads to
lower level of planned investment spending
Retained earnings
Past profits used to finance investment spending
The higher the current capacity
the lower the investment spending
investment spending slumps
periods of low investment spending
accelerator principle
A higher growth rate of real GDP leads to higher planned investment spending but a lower growth rate of GDP leads to lower planned investment spending
Inventories
Stocks of goods held to satisfy future sales
Inventory investment
the value of the change in total inventories held in the economoy during a given period
Unplanned inventory investment
Occurs when actual sales are more or less than businesses expected, leading to unplanned changes in inventories
Actual investment spending
The sum of planned investment spending and unplanned inventory investment
Unplanned investment + Planned investment
positive unplanned investment
sales are less than had been forecast
negative unplanned investment
Sales are greater than forecast
Housing bubble
People were buying housing based on unrealistic expectations about future price increases
inventory overhang
A high level of unplanned inventory investment throughout the economy
Planned aggregate spending
The total amount of planned spending in the economy
= Consumption + Planned Investment
GDP =
GDP = AEplanned + Iunplanned
income expenditure equilibrium
When aggregate output, measured by real GDP, is equal to planned aggregate spending
Income-expenditure equilibrium GDP
The level of real GDP at which real GDP equals planned aggregate spending
Y*
Keynsian cross
a diagram that identifies income-expenditure equilibrium as the point where the planned aggregate spending line crosses the 45 degree line
Leading indicator of future economic activity
changes in inventories
∆Y* =
∆Y* = Multiplier x ∆AAEplanned
