chapter 2

Question 1

what’s the difference between expenditure on the gross domestic product and GDE?

Answer 1

Expenditure on the gross domestic product (GDP) is spending on goods and services produced inside the border of a county, including exports and excluding imports [C + I + G + (X –IM)].

This differs from gross domestic expenditure (GDE), which is the total value of spending within the borders of a country (C + I + G), including imports but excluding exports, since spending on exports takes place outside the borders of the country.

Question 2

If GDE is greater than GDP, what happens to a country and visa versa?

Answer 2

if GDE is greater than GDP it follows that the country is importing more than it’s exporting whilst if the GDP is greater than GDE the country is exporting more than it’s importing

Question 3

what are the 4 major spenders in the economy?

Answer 3

The four major spenders in the economy are households (C), government (G), private firms (I) and the foreign sector (X-IM)

Question 4

what are the 3 types of goods that are part of the final consumption by households?

Answer 4

In the national accounts of South Africa, final consumption expenditure by households (C) is classified in terms of durable goods, semi-durable goods, nondurable goods and services

Question 5

what consists of the final consumption of government expenditure?

Answer 5

Final consumption expenditure by government (G) consists of the expenditure of the central government on final goods and services

Question 6

what is gross capital formation (I)?

Answer 6

Gross capital formation (I) is the spending by households, private firms and government on residential and non-residential capital goods.

Question 7

What does the international sector consist of?

Answer 7

The international sector is represented by exports and imports

Question 8

what are exports?

Answer 8

Exports are goods that are produced within the country but sold to the rest of the world. South Africa’s exports consist mainly of gold and other minerals.

Question 9

what are imports?

Answer 9

Imports are goods that are produced in the rest of the world but purchased for use in domestic economy and they therefore do not form part of expenditure on GDP. South Africa’s imports consist mainly of capital and intermediate goods, which are used in the production process

Question 10

what is the consumption function and what is the relationship between consumption and income?

Answer 10

consumption is a function of income (C = f (Y)) and a positive relationship exists between income and consumption since an increase in income leads to an increase in consumption.

Question 11

what happens to consumer spending when income increases and what is the state of consumer spending?

Answer 11

An increase in income increases consumer spending, but the increase in consumer spending is less than the increase in income

Question 12

what is consumer spending determined by?

Answer 12

Consumption spending by households is determined mainly by their current income.

Question 13

what relationship does the marginal propensity to consume captures?

Answer 13

The marginal propensity to consume (c) captures the relationship between an increase in income and corresponding but smaller increase in consumption.

Question 14

what is the value for the marginal propensity to consume?

Answer 14

the value for the marginal propensity to consume is usually between 0 and 1

Question 15

how does households earn an income?

Answer 15

Households earn an income from owning the factors of production

Question 16

what does the marginal propensity to save indicate?

Answer 16

the marginal propensity to save (s) indicated the proportion of a change in income that will be saved.

Question 17

what is the formula for the marginal propensity to save?

Answer 17

the marginal propensity to save is s = 1 – c

Question 18

what is the formula for the consumption function and what does it mean?

Answer 18

The consumption function is a behavioural equation that shows the behaviour of households - C = co + cYD

This equation state that consumption spending C is equal to autonomous consumption (co) plus a proportion of disposable income cYD

Question 19

what is disposible income and what is the formula for it?

Answer 19

the income households receive from the production of goods and services minus the income taxes they pay to government.

In symbols it is written as: YD = Y–T

Question 20

what effect does taxes have on disposable income and consumption spending and what’s the chain of events for it?

Answer 20

Taxes reduce disposable income available to households and, as disposable income declines, so too does consumption spending decline in the economy

T↑ ⇒ YD↓ ⇒ C↓

Question 21

what happens to disposable income and consumption spending when taxes decrease and what’s the chain of events?

Answer 21

If taxes decrease, disposable income increases and so does consumption spending by households

T↓ ⇒ YD↑ ⇒ C↑

Question 22

what is the relationship between production, income, consumption spending and disposable income?

Answer 22

An increase in production also increases disposable income since income is derived from production. The higher the level of production, the higher the income received by households and the higher their disposable income and consumption.

Y↑⇒ YD↑ ⇒ C↑

Question 23

what does the cYD part (disposable income in the consumption function) also known as?

Answer 23

The cYD part of the consumption function is also known as induced consumption since it is caused by or results from a change in income.

Question 24

what is the part of consumption spending that is not influenced by the level of disposable income?

Answer 24

autonomous consumption, and it is represented by co in the equation.

Question 25

what are the different sources of autonomous spending?

Answer 25

Autonomous consumption can also be regarded as consumption that is financed from sources other than income, say, inheritances, past savings, gifts or credit.

Question 26

what are the non-income determinants other than the level of income?

Answer 26

Non-income determinants are all the factors – other than the level of income – that influence consumer spending, such as interest rates, expectations, wealth, income distribution, access to credit, health, and so on.

Question 27

What happens to consumption spending if autonomous consumption, due to a rise in consumer confidence, increases?

Answer 27

This will have the effect of increasing consumption spending.

c0↑ ⇒ C↑

Question 28

what is the relationship between the level of output, income, savings and consumption spending?

Answer 28

The higher the level of output and income in the economy, the higher are consumption spending and savings too.

Question 29

what is the formula for the savings function and the marginal propensity to save?

Answer 29

the savings function is S = –co + (1–c)YD. The (1–c) is the marginal propensity to save (s).

Question 30

what is the relationship between the marginal propensity to save and marginal propensity to consume and what does it mean for households?

Answer 30

The higher the marginal propensity to consume, the lower the marginal propensity to save. In other words, as households consume a larger proportion of their income they save a smaller proportion

Question 31

what does an increase in the marginal propensity to consume mean for disposable income and consumption curve?

Answer 31

An increase in the marginal propensity to consume implies that at each level of disposable income households spend a larger proportion of that disposable income on consumption and that the consumption curve is steeper.

Question 32

what does a decrease in the marginal propensity to consume mean for disposable income and consumption curve?

Answer 32

A decrease in the marginal propensity to consume, on the other hand, implies that a lower proportion of disposable income is spent on consumption and that the consumption curve is flatter.

Question 33

Indicate what happens to the consumption curve if autonomous consumption changes.

Answer 33

A change in autonomous consumption changes the vertical intercept and the consumption curve shifts. This might be due to a change in consumer confidence.

Question 34

what happens to the consumption curve is there is an increase in autonomous spending?

Answer 34

An increase in autonomous consumption increases the vertical intercept and the consumption curve shifts upwards by an amount equal to the increase in autonomous consumption.

Question 35

what happens to the consumption curve is there is an increase in autonomous spending?

Answer 35

A decrease in autonomous consumption, on the other hand, decreases the vertical intercept and the consumption curve shifts downwards by an amount equal to the decrease in autonomous consumption.

Question 36

Distinguish between real and financial investment

Answer 36

Investment or real investment is spending on additions to the capital stock (machinery, structures, inventories, etc.). Such investment is undertaken in order to make profits in the future.

Financial investment is investment in shares and other financial instruments. When people put money on deposit with a bank or buy bonds or shares, they are making a financial investment, on which they will earn a return.

Question 37

Explain why investment is an autonomous variable and what influences it.

Answer 37

For now in the goods market we will simply assume that investment is an autonomous variable that is determined by exogenous factors such as:

• interest rates – a higher interest rate decreases investment
• expectations – improved expectations about the future increase investment
• business confidence – higher business confidence increases investment
• regulations – a more investment-friendly environment increases investment

Question 38

What happens to the vertical intercept and investment curve when autonomous investment increases or decreases?

Answer 38

A change in autonomous investment changes the vertical intercept. In the event of an increase in investment the vertical intercept increases and the investment curve shifts upwards. The opposite occurs if autonomous investment declines.

Question 39

what is the relationship between savings and investments?

Answer 39

An increase in savings does not automatically lead to an increase in investment. However, in this goods market model, an increase in investment does lead to an increase in savings

Question 40

Distinguish between a budget deficit and a budget surplus.

Answer 40

A budget deficit exists when the government’s total expenditure, consisting of purchases of goods and services (G) exceeds its revenue, consisting of taxes (T).

Budget deficit = G > T

A budget surplus exists when government’s revenue, consisting of taxes (T), exceeds its total expenditure, consisting of purchases of goods and services (G).

Budget surplus = G < T

Question 41

what is the symbol of the demand of goods and what relationship does it have with income?

Answer 41

Z means the demand for goods.

We are in the process of developing an economic model that explains how the demand for goods determines the level of output and income.
Z -> Y

Question 42

what’s the formula for the demand of goods?

Answer 42

Z = C + Ī + G

Question 43

what is the formula for the demand of goods?

Answer 43

Z = c0 + c(Y–T) + Ī + G

Question 44

explain the equilibrium condition in the goods market?

Answer 44

equilibrium condition states that Y = Z.

With the level of output and income Y on the horizontal axis and the demand for goods Z on the vertical axis, the 45 degree line indicates possible equilibrium positions

Question 45

what is full employment?

Answer 45

• Full employment can be described as a situation in which
  all resources (labour, capital, land and entrepreneurship)
  are used to produce goods and services.

Question 46

what is an unemployment gap or output/income gap?

Answer 46

the distance between Yo and Yf.

Question 47

what are exogenous variables and what are they in the goods model?

Answer 47

The variables that we can control. Government has two instruments it can use to influence the level of output, namely government spending (G) and taxes (T), both of which are policy variables of fiscal policy.

Question 48

what are the endogenous variables and what are they in the goods market?

Answer 48

Variables that can not be controlled for example the value of investment is not determined by a variable such as the level of production