chapter 21 Flashcards
what does desired mean with regards to expenditure?
“Desired” expenditure is not just a list of what consumers and firms would buy if they had no constraints on their spending—it is much more realistic than that.
Desired expenditure is what consumers and firms would like to purchase, given their real-world constraints of income and market prices.
def/form. desired aggregate expenditure
The sum of desired or planned spending on domestic output by
households, firms, governments, and foreigners is desired aggregate
expenditure
AE = C + I + G + (X - IM)
def. autonomous expenditures
Elements of expenditure that do not change systematically with national income
def. induced expenditure
Any component of expenditure that is systematically related to
national income
what are the 3 main assumptions of the simplest short-run macro model?
- there is no trade with other countries—that is, the economy we are studying is a closed economy;
- there is no government—and hence no taxes; and
- the price level is constant
what is consumption determined by in the simplest theory?
primarily by current disposable income (Yd)
def. disposable income
is the amount of income households receive after deducting what they pay in taxes and adding what they receive in transfers
what are the two possible uses of disposable income?
consumption (c)
savings (S)
What are the 4 key factors influencing desired consumption?
- Disposable income
- Wealth
- Interest rates
- Expectations about future income
simplest consumption function
C = a + b *YD
**Holding constant other determinants of desired consumption, an increase in disposable income is assumed to lead to an increase in desired consumption
**slope of the simple consumption function (b) is less than 1
marginal propensity to consume
The marginal propensity to consume (MPC) relates the change in desired consumption to the change in disposable income that brings it about.
MPC = change in C/ change in YD
**slope of the consumption function
average propensity to consume (APC)
equal to total consumption divided by total disposable income
APC= C/Yd
marginal propensity to save (MPS)
relates the change in desired saving to the change in disposable income that brings it about.
MPS= change in S/ change in Yd)
**slope of the saving function
average propensity to save (APS)
equal to total desired saving divided by total disposable income
APS= S/Yd
APC + APS = _____
1
-because all disposable income is either spent or saved, it follows that the fractions of income consumed and saved must account for all income
MPC + MPS= _____
1
-the fractions of any increment to income consumed and saved must account for all of that increment
if consumption function shifts upward, the saving function must shift __________
downward
what is the most volatile component of GDP?
investment expenditure
what are changes in investment expenditure are strongly associated with ____________
short-run fluctuations
what are the 3 important determinants of aggregate investment expenditure are:
- the real interest rate
- changes in the level of sales
- business confidence
the real interest rate is the opportunity cost for what three things?
- investment in new plants and equipment
- investment in inventories
- investment in residential construction
all three components of desired investment expenditure are _______ related to the real interest rate
negatively
the higher the level of production and sales, the _________ the desired stock of inventories
larger
**changes in the rate of sales cause temporary bouts of investment in inventories
what happens when business confidence improves?
firms want to invest now
so as to reap future profits
**business confidence and consumer confidence may feed off of one another
T or F: desired investment is autonomous, unaffected by changes in national income
true
**simplifying assumption but one can think that investment is taken for future benefit, and thus not affected by the current level of GDP
T or F: desired investment is constant
false, its autonomous
the AE function description
- relates desired aggregate expenditure to actual national income
- we mean real as opposed to nominal variables
desired aggregate expenditure function:
AE= C + I
marginal propensity to spend
z= change in AE/ change in Y
*slope of the AE function
Marginal propensity to spend (z) is the amount of extra total expenditure induced when national income raises by $1.
Marginal propensity to consume (MPC) is the amount of extra consumption expenditure induced when households disposable income rises by $1
what is an assumption when considering equilibrium national income
Firms are able and willing to produce any amount of output that is demanded of them and without changing prices
where does the equilibrium level of national income occur?
where desired aggregate expenditure equals actual national income
AE = Y
If desired aggregate expenditure exceeds actual output:
- what is happening to inventories?
* there is pressure for output to rise
if desired aggregate expenditure is less than actual output:
- what is happening to inventories?
* there is pressure for output to fall
what is equilibrium condition?
Y= AE(Y)
**Equilibrium national income is that level of national income where desired aggregate expenditure equals actual national income
the difference between desired saving and desired investment is always equal to the difference between ________ and _________
actual national income and desired aggregate expenditure
S - I = W
Y – C – I = W
Y – AE =W
when is the economy in equilibrium with regards to desired investment and saving?
The economy is in equilibrium when desired investment equals desired saving
What are the two kinds of shifts that can occur with the AE function?
- AE function can shift parallel to itself
- -effect of changes in: wealth, interest rate, expectations, sales - the slope of the AE function can change
- -change the marginal propensity to spend (z)
- -z= MPC
What are the two important propositions from the simple model of national income determination?
What is a third general proposition?
- rise in AE for all levels of Y –> shifts AE up –> increases equilibrium national income
- Fall in AE for all levels of Y –> shifts AE down –> reduces equilibrium national income
- an increase in the marginal propensity to spend (z) –> steepens the AE curve –> increases equilibrium national income
what is the simple multiplier?
change in Y/ change in A = 1 /1-z
-where z is the marginal propensity to spend out of national income and change in A is the change in autonomous expenditure
what does it mean that the multiplier exceeds 1?
the change in autonomous expenditure increases
equilibrium national income by a multiple of the initial change in autonomous expenditure.
describe how economic fluctuations can be self-fulfilling prophecies
Households and firms base their desired investment and consumption partly on their expectations of the future:
–> changes in expectations can lead to real changes in the current state of the economy
what is an example of an economic fluctuation being a self-fulfilling prophecy
- imagine that firms feel optimistic about the future
- this increases their desired investment, shifting up the AE curve
- this increases Y, justifying the initial optimism
