Chapter 3 - National Income (2nd Half) Flashcards
Disposable Income
Total income minus total taxes (Y-T)
Consumption Function
General Functional Form: C = C(Y-T)
Autonomous Consumption
Consumption undertaken even when disposable income is 0 (eg. spending on food)
Why is consumption != 0 when disposable income = 0
Autonomous consumption occurs even when disposable income is 0 (meaning induced consumption is also 0).
Marginal Propensity to Consume (MPC)
Change in consumption (C) when disposable income increases by $1. (0 <= MPC <= 1)
What is the slope of the consumption function C(Y-T)?
MPC
Investment Function
General Functional Form: I = I(r)
Equilibrium for AD/AS model
Y = C(Y-T) + I(r) + G
Y, T, G are fixed
How does aggregate demand adjust to equal aggregate supply (fixed)?
Real interest rate adjusts (all other variables in AD are fixed)
Real Interest Rate (r)
Nominal interest rate corrected for inflation. It is the opportunity cost of using one’s funds to finance investment spending
How is Aggregate Supply represented in the market for goods and services
The Production Function
Y = F(K, L)
Y, K, L are fixed by assumption
Where does demand for loanable funds come from?
Investment. Firms borrow money to spend on PPE, buildings, and other business investments. Consumers borrow to buy new house (residential investment).
Where does the supply of loanable funds come from?
Savings (Y-C-G). Composed of:
Private saving
Public saving
Private Saving
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).
Public Saving
Government contribution to saving if it does not spend all tax revenue it receives (T-G)
How does the government pay off bonds when they have a budget deficit?
They sell more bonds and use the revenue from the new bonds to pay off older bonds.
Budget Surplus and Budget Deficit
If T > G -> Budget Surplus
If T < G -> Budget Deficit
If T = G -> Balanced Budget (Public Saving = 0)
How does the government finance during a budget deficit?
The government issues government bonds (borrows from households).
Why can the loanable funds supply curve be vertical?
If national saving does not depend on real interest rate, the loanable funds supply curve is vertical (Y, T, G are constant)
True or False: It is possible to have equilibrium in the goods market, but not in the loanable funds market?
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.
What events shift the savings curve?
Public Saving: Fiscal Policy (changes in G or T)
Private Saving: Change in preferences, Tax laws introduced that affect saving
What events shift the investment curve?
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)
