Chapter 11 Flashcards
The Multiplier’s Overall Effect on the Economy compared to initial autonomous increase or decrease
The overall affect will be more then the initial increase because of a chan reaction effect
Simplifying Assumptions for Multiplier and why (4x2)
- Producer’s willing to supply additional output at fixed price. (Isolates demand affect when price changes).
- Interest Rate is given.(Ensures it and the investment levels are fixed).
- No Government spending or taxes (Ensures GDP=Disposable Income)
- Exports and Imports=0 (No trade)
The Multiplier Chain Reaction Cycle
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
Marginal Propensity to consume and equation
the change in consumer spending when disposable income rises or decreases. (change in consumer spending / change in disposable income).
marginal propensity to save and equation
increase in household savings when disposable income rises, 1-MPC
example of multiplier effect
spending rises by 100billion, that 100billion becomes income of another individual, then MPCx100 billion is the extra income of another and so on
Multiplier Formula (Total Increase in RGDP)
(1/1-MPC)x(initial change)
autonomous change in aggregate expenditure
Initial Change in the desired level of spending of firms/H.H/gov at given level of GDP
AE, Y
Aggregate expenditure, GDP
Change in Real GDP by the multiplier equation
(1/1-MPC)x(AE0(change in aggregate spendng)
is the change in real GDP / change in Aggregate expenditure = to the multiplier? Yes or no?
Yes
The multiplier defined
ratio of total change in real GDP caused by autonomous change in aggregate expenditure to the size of that autonomous change.
greater the mpc=
greater the multiplier as less income is leaked out from spending
Disposable Income definition and equation and the relationship trend with GDP
GDP+TR-T, Income left after taxes paid and government transfers are received. Trend is a direct relationship
Why is Disposable Income=RGDP
no transfers or taxes
Individual Consumption Function and equation
Individual household consumer spendings and how it varies with their disposable income c=a+(mpc)x(yd)
what does each letter stand for in the consumption function- c=a+(mpc)x(yd)
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
what is the consumption function of the entire economy and how is it similar to a consumers (2)
- every letter is capitalized
- C=A+MPCxYD
- disposable income= RGDP
trends of the consumption function graphed (3)
- 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
what shifts the consumption function (3)
- change in autonomous spending
- change in expected future disposable income
- change in aggregate wealth
change in autonomous spending shifts ex increase is_____ and decrease is ___
- increase = shift up
- decrease = shift down
change in expected future and current disposable income (2)
- expected future income increase = current spending increase
- current disposable income increases = spend more
permanent income hypothesis
consumer spending depends on expected income over long term
life cycle hypothesis
consumer plans spending over life time
- spend during retirement
- save during years working
Planned Investment Spending and what it depends on (3)
- 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)
- Planned Investment Spending and Interest Rate (2)
- 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
opportunity cost of interest rate and purchasing investments
instead of purchasing equipment, firm could lend funds and earn interest
RGDP is a ____ of future sales because firms ____.
proxy, don’t know what will happen to their sales every year
for a given level of current capacity the ___ the future expected RGDP the _____ investment spending
lower, decreased
higher, increased
for a given level of expected future RGDP the _____ the current capacity, the ______ the invesment spending
higher, decreased (firms realize they over produce and want to produce less)
lower, increased (firms realize they under produce and want to produce more)
Accelerator Principle with investment spending
small decrease or increase in investment will have a much larger impact on RGDP due to the multiplier effect
Accelerator Principle Example. Explain how expectations can lead to inflation or recession
- lower expected sales lower investment spending which accelerates recession
- higher expected sales increase investment spending which accelerates expansion
Inventories
stocks of goods to satisfy future sales
Actual investment spending
Iplanned + Iunplanned
Inventory Investment
value of change in total inventories held in economy during given period.
unplannned inventories
over/under estimate of investment spending, actual sales >or< expected sales
increase in inventories
decreasing in inventories are signs of what and are they positive or negative
- positive and economy is contracting (demand form buyers decrease therefore withdraw decreases)
- negative and economy is expanding
AEplanned and equation (3)
Planned aggregate spending of economy
AE planned= C + Iplanned
AE planned= A+MPCxYD + Iplanned
Relate AEplanned and GDP and Disposable income at Eqbm
At the equilibrium AEplanned=RealGDP=Disposable Income and Iunplanned is zero
AE planned and consumption function relate-ability
the planned Aggregate expenditure is basically the combination of all consumer consumption functions in the economy plus a upwards shift of planned investment.
Trends of AEplanned graphed
- 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
If firms produce too much Iunplanned
if firms produce too little Iunplanned
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
Income Expenditure Equilibrium Equation
GDP=AEplanned + Iunplanned (Iunplanned is zero at eqbm)
Whenever Real GDP exceeds AEplanned,
Iunplanned is positive
Whenever Real GDP is less than AEplanned
Iunplanned is negative
What is income expenditure equilibrium and what can RGDP be replaced wth
It is when AEplanned output = aggregate planned spending, since this is true we replace GDP with Y*
describe what happens if economy is currently producing at a point where RGDP less then AE
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*
name 2 shifts that cause the aggregate expenditure to shift
- change in planned investment due to the interest rate
- shift of the aggregate consumption function ex change in autonomous spending
Describe what happens if the AE planned shifts up from the equilibrium point where AE=Y*
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.
Paradox of Thrift
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
effects of international trade on GDP Multiplier
- 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
economic interdependance (3) think about trade linkage with countries, what happens if one countries exports decline what would happen to another's imports
- 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
