Chapter 11

Question 1

The Multiplier’s Overall Effect on the Economy compared to initial autonomous increase or decrease

Answer 1

The overall affect will be more then the initial increase because of a chan reaction effect

Question 2

Simplifying Assumptions for Multiplier and why (4x2)

Answer 2

1. Producer’s willing to supply additional output at fixed price. (Isolates demand affect when price changes).
2. Interest Rate is given.(Ensures it and the investment levels are fixed).
3. No Government spending or taxes (Ensures GDP=Disposable Income)
4. Exports and Imports=0 (No trade)

Question 3

The Multiplier Chain Reaction Cycle

Answer 3

increase in disposable income (profits and wages) leads to increase in consumer and investment spending which leads to increase in aggregate output which increases disposable income

Question 4

Marginal Propensity to consume and equation

Answer 4

the change in consumer spending when disposable income rises or decreases. (change in consumer spending / change in disposable income).

Question 5

marginal propensity to save and equation

Answer 5

increase in household savings when disposable income rises, 1-MPC

Question 6

example of multiplier effect

Answer 6

spending rises by 100billion, that 100billion becomes income of another individual, then MPCx100 billion is the extra income of another and so on

Question 7

Multiplier Formula (Total Increase in RGDP)

Answer 7

(1/1-MPC)x(initial change)

Question 8

autonomous change in aggregate expenditure

Answer 8

Initial Change in the desired level of spending of firms/H.H/gov at given level of GDP

Question 9

AE, Y

Answer 9

Aggregate expenditure, GDP

Question 10

Change in Real GDP by the multiplier equation

Answer 10

(1/1-MPC)x(AE0(change in aggregate spendng)

Question 11

is the change in real GDP / change in Aggregate expenditure = to the multiplier? Yes or no?

Answer 11

Yes

Question 12

The multiplier defined

Answer 12

ratio of total change in real GDP caused by autonomous change in aggregate expenditure to the size of that autonomous change.

Question 13

greater the mpc=

Answer 13

greater the multiplier as less income is leaked out from spending

Question 14

Disposable Income definition and equation and the relationship trend with GDP

Answer 14

GDP+TR-T, Income left after taxes paid and government transfers are received. Trend is a direct relationship

Question 15

Why is Disposable Income=RGDP

Answer 15

no transfers or taxes

Question 16

Individual Consumption Function and equation

Answer 16

Individual household consumer spendings and how it varies with their disposable income c=a+(mpc)x(yd)

Question 17

what does each letter stand for in the consumption function- c=a+(mpc)x(yd)

Answer 17

c = HH consumer spendings
a = autonomous consumer spending, y intercept, what a family could spend even with "zero" income 
yd= HH disposable income
MPC= marginal propensity to consume

Question 18

what is the consumption function of the entire economy and how is it similar to a consumers (2)

Answer 18

• every letter is capitalized
• C=A+MPCxYD
• disposable income= RGDP

Question 19

trends of the consumption function graphed (3)

Answer 19

• slope is the MPC
• direct relationship with consumer spending on Y-axis and disposable income on the x-axis
• if disposable income rises by a change in yd then consumer spending rises by a change in c

Question 20

what shifts the consumption function (3)

Answer 20

• change in autonomous spending
• change in expected future disposable income
• change in aggregate wealth

Question 21

change in autonomous spending shifts ex increase is_____ and decrease is ___

Answer 21

• increase = shift up

- decrease = shift down

Question 22

change in expected future and current disposable income (2)

Answer 22

• expected future income increase = current spending increase
• current disposable income increases = spend more

Question 23

permanent income hypothesis

Answer 23

consumer spending depends on expected income over long term

Question 24

life cycle hypothesis

Answer 24

consumer plans spending over life time

• spend during retirement
• save during years working

Question 25

Planned Investment Spending and what it depends on (3)

Answer 25

- investment spending that businesses intend to purchase during a given period Depends on 1. Interest Rate 2. Expected Future Real GDP 3. Current level of production capacity (Inventories)

Question 26

1. Planned Investment Spending and Interest Rate (2)

Answer 26

- indirect relationship (planned investment spending is high when interest rates are low) - firms investment spending projects to go ahead if they expect a rate of return higher then the cost of funds required to borrow to finance project

Question 27

opportunity cost of interest rate and purchasing investments

Answer 27

instead of purchasing equipment, firm could lend funds and earn interest

Question 28

RGDP is a ____ of future sales because firms ____.

Answer 28

proxy, don't know what will happen to their sales every year

Question 29

for a given level of current capacity the ___ the future expected RGDP the _____ investment spending

Answer 29

lower, decreased | higher, increased

Question 30

for a given level of expected future RGDP the _____ the current capacity, the ______ the invesment spending

Answer 30

higher, decreased (firms realize they over produce and want to produce less) lower, increased (firms realize they under produce and want to produce more)

Question 31

Accelerator Principle with investment spending

Answer 31

small decrease or increase in investment will have a much larger impact on RGDP due to the multiplier effect

Question 32

Accelerator Principle Example. Explain how expectations can lead to inflation or recession

Answer 32

- lower expected sales lower investment spending which accelerates recession - higher expected sales increase investment spending which accelerates expansion

Question 33

Inventories

Answer 33

stocks of goods to satisfy future sales

Question 34

Actual investment spending

Answer 34

Iplanned + Iunplanned

Question 35

Inventory Investment

Answer 35

value of change in total inventories held in economy during given period.

Question 36

unplannned inventories

Answer 36

over/under estimate of investment spending, actual sales >or< expected sales

Question 37

increase in inventories | decreasing in inventories are signs of what and are they positive or negative

Answer 37

- positive and economy is contracting (demand form buyers decrease therefore withdraw decreases) - negative and economy is expanding

Question 38

AEplanned and equation (3)

Answer 38

Planned aggregate spending of economy AE planned= C + Iplanned AE planned= A+MPCxYD + Iplanned

Question 39

Relate AEplanned and GDP and Disposable income at Eqbm

Answer 39

At the equilibrium AEplanned=RealGDP=Disposable Income and Iunplanned is zero

Question 40

AE planned and consumption function relate-ability

Answer 40

the planned Aggregate expenditure is basically the combination of all consumer consumption functions in the economy plus a upwards shift of planned investment.

Question 41

Trends of AEplanned graphed

Answer 41

- direct relationship, as GDP increases so does AEplanned consumer spending - higher level of GDP=higher disposable income=higher spendings (AEplanned depends on RGDP) - slope of AE is the MPC

Question 42

If firms produce too much Iunplanned | if firms produce too little Iunplanned

Answer 42

will be positive as inventories are piling up and firm will need to produce less will be negative as inventories are declining and firms will need to produce more

Question 43

Income Expenditure Equilibrium Equation

Answer 43

GDP=AEplanned + Iunplanned (Iunplanned is zero at eqbm)

Question 44

Whenever Real GDP exceeds AEplanned,

Answer 44

Iunplanned is positive

Question 45

Whenever Real GDP is less than AEplanned

Answer 45

Iunplanned is negative

Question 46

What is income expenditure equilibrium and what can RGDP be replaced wth

Answer 46

It is when AEplanned output = aggregate planned spending, since this is true we replace GDP with Y*

Question 47

describe what happens if economy is currently producing at a point where RGDP less then AE

Answer 47

Currently there is more planned spending then aggregate output (Y) firms realize that they a producing too little as unplanned inventories are negative, so next year they plan to produce more moving the point along the curve to Y*

Question 48

name 2 shifts that cause the aggregate expenditure to shift

Answer 48

- change in planned investment due to the interest rate | - shift of the aggregate consumption function ex change in autonomous spending

Question 49

Describe what happens if the AE planned shifts up from the equilibrium point where AE=Y*

Answer 49

The graph shifted up because there was an increase in autonomous spending which now causes more spending then output at the original eqbm. Iunplanned is negative so next year the planned output level of firms must increase so they produce more and move to a new point along the AE line.

Question 50

Paradox of Thrift

Answer 50

What looks like good at first is really bad in the end due to the multiplier. Ex during recession people save shift then decrease spending which shifts the consumption function and the AE function worsening recession

Question 51

effects of international trade on GDP Multiplier

Answer 51

- exports are like increase in consumer spending | - multiplier is weaker with trade as imports are leakage from the economy, imports don't add to GDP

Question 52

``` economic interdependance (3) think about trade linkage with countries, what happens if one countries exports decline what would happen to another's imports ```

Answer 52

- lower exports affects trade partners - countries have recessions and recoveries at same time - countries exports are another's imports this cause countries to fall together ex the pandemic