Chapter 3 - National Income (2nd Half)

Question 1

Disposable Income

Answer 1

Total income minus total taxes (Y-T)

Question 2

Consumption Function

Answer 2

General Functional Form: C = C(Y-T)

Question 3

Autonomous Consumption

Answer 3

Consumption undertaken even when disposable income is 0 (eg. spending on food)

Question 4

Why is consumption != 0 when disposable income = 0

Answer 4

Autonomous consumption occurs even when disposable income is 0 (meaning induced consumption is also 0).

Question 5

Marginal Propensity to Consume (MPC)

Answer 5

Change in consumption (C) when disposable income increases by $1. (0 <= MPC <= 1)

Question 6

What is the slope of the consumption function C(Y-T)?

Answer 6

MPC

Question 7

Investment Function

Answer 7

General Functional Form: I = I(r)

Question 8

Equilibrium for AD/AS model

Answer 8

Y = C(Y-T) + I(r) + G
Y, T, G are fixed

Question 9

How does aggregate demand adjust to equal aggregate supply (fixed)?

Answer 9

Real interest rate adjusts (all other variables in AD are fixed)

Question 10

Real Interest Rate (r)

Answer 10

Nominal interest rate corrected for inflation. It is the opportunity cost of using one’s funds to finance investment spending

Question 11

How is Aggregate Supply represented in the market for goods and services

Answer 11

The Production Function
Y = F(K, L)
Y, K, L are fixed by assumption

Question 12

Where does demand for loanable funds come from?

Answer 12

Investment. Firms borrow money to spend on PPE, buildings, and other business investments. Consumers borrow to buy new house (residential investment).

Question 13

Where does the supply of loanable funds come from?

Answer 13

Savings (Y-C-G). Composed of:
Private saving
Public saving

Question 14

Private Saving

Answer 14

Households use their savings to make bank deposits and purchase bonds and other assets. These funds become available for firms to borrow and finance investment spending ((Y-T)-C).

Question 15

Public Saving

Answer 15

Government contribution to saving if it does not spend all tax revenue it receives (T-G)

Question 16

How does the government pay off bonds when they have a budget deficit?

Answer 16

They sell more bonds and use the revenue from the new bonds to pay off older bonds.

Question 17

Budget Surplus and Budget Deficit

Answer 17

If T > G -> Budget Surplus
If T < G -> Budget Deficit
If T = G -> Balanced Budget (Public Saving = 0)

Question 18

How does the government finance during a budget deficit?

Answer 18

The government issues government bonds (borrows from households).

Question 19

Why can the loanable funds supply curve be vertical?

Answer 19

If national saving does not depend on real interest rate, the loanable funds supply curve is vertical (Y, T, G are constant)

Question 20

True or False: It is possible to have equilibrium in the goods market, but not in the loanable funds market?

Answer 20

False. Real interest rate (r) adjusts to equilibrate the goods market and loanable funds market simultaneously. Thus, equilibrium in the goods market occurs IFF the loanable funds market is also in equilibrium.

Question 21

What events shift the savings curve?

Answer 21

Public Saving: Fiscal Policy (changes in G or T)
Private Saving: Change in preferences, Tax laws introduced that affect saving

Question 22

What events shift the investment curve?

Answer 22

Some Technological Innovations: Firms must buy new goods to take advantage of technological innovations (increases efficiency and saves money in the long run)
Tax Laws that affect investment (eg. Investment tax credit)