Chapter 6 Flashcards
What does the subscript “a” indicate when added to the letters that represent the various categories of expenditure? (C= consumption, I = investment, G = government purchases, X-IM = net exports)
It indicates the desired expenditure in these categories
What does desired expenditure mean?
“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.
What does the equation of desired aggregate expenditure represent?
It represents the sum of desired or planned spending on domestic output by households, firms, governments, and foreigners
What is the equation for desired aggregate expenditure?
AE = C + I + G + (X − IM)
What are the elements of aggregate expenditure that do not change systemically with national income called?
Autonomous expenditures
What are the components of aggregate expenditure that do change systemically in response to changes in national income called?
Induced expenditures
What are the 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
the price level is constant.
What is the equation of disposable income?
Disposable income = household income - taxes
What is saving?
It is disposable income not spent on consumption
What is the consumption function?
It is the relationship between desired consumption expenditure and all the variables that determine it
What is desired consumption determined by?
It is determined by disposable income, wealth, interest rates, and expectations about the future
What is the equation for Income?
Income = Consumption expenditures + Savings
What is the equation for APC?
APC = C/Yd
APC = desired consumption / level of disposable income
What is the equation for APS?
APS = S/Yd
APS = desired saving / disposable income
What does APC + APS equal to?
APC + APS = 1
What is the equation for mpc?
mpc = ΔC/ΔYd
mpc = change in desired consumption / change in disposable income
What is the equation for mps?
mps = ΔS/ΔYd
mps = change in desired saving / change in disposable income
What does the slope of the Savings function equal to?
mps
What does the slope of the Consumption function equal to?
mpc
What does mpc + mps equal to?
1
What does APC stand for?
Average propensity to consume
What does mpc stand for?
Marginal propensity to consume
What does the constant slope of the consumption function show?
That the MPC is the same at any level of disposable income
What do households decide?
How much to consume and how much to save
What does APS mean?
Average propensity to save
What does mps mean?
Marginal propensity to save
Why does APC + APS = 1?
the fractions of income consumed and saved must account for all income because all disposable income is either spent or saved
Why does MPC + MPS = 1?
Because the fractions of any increment to income consumed and saved must account for all that increment
In what situations does the consumption function shift upward?
- Increase in wealth
- Decrease in interest rates
- Increase in optimism about the future
In what situations does the consumption function shift downward?
- Decrease in wealth
- Increase in interest rates
- Decrease in optimism about the future
In what situations does the saving function shift downward?
- Increase in wealth
- Decrease in interest rates
- Increase in optimism about the future
In what situations does the saving function shift upward?
- Decrease in wealth
- Increase in interest rates
- Decrease in optimism about the future
What are the 3 categories of investment?
Inventory accumulation
Residential construction
New plant and equipment
What are the characteristics of investment expenditure?
It is the most volatile component of GDP and is strongly associated with aggregate economic fluctuations
What are the determinants of desired investment expenditure?
Real interest rate
Changes in level of sales
Business confidence
What cost is associated with investement?
Opportunity cost
What does a higher real interest rate lead to?
A higher opportunity cost of investment
What do higher levels of sales lead to?
Larger stock of inventories
What does does a change in the rate of sales do?
It leads to temporary bouts of investment/disinvestment in inventories
What does optimism in desired investment and business confidence lead to (expectations about the future)?
Increased desired investment
What does pessimism in desired investment and business confidence lead to (expectations about the future)?
Decreased desired investment
What does the aggregate expenditure (AE) function relate?
It relates the level of desired aggregate expenditure to the level of actual income
What is aggregate expenditure equal to in the absence of government and international trade?
It is equal to desired consumption (or consumption function) plus desired investment (or investment function)
AE = C + I
What is the slope of the AE function?
It is the marginal propensity to consume
What occurs when desired aggregate expenditure exceeds actual income (value of production)?
Inventories fall and there is pressure for all national income to rise (need to increase production)
What occurs when desired aggregate expenditure is less than actual income (value of production)?
Inventories rise and there is pressure for actual national income to fall (need to reduce production)
When does the equilibrium level of national income occur?
When desired aggregate expenditure equals national income
If actual Y < Y0 then desired income will exceed national income meaning that…
Output will rise
If actual Y > Y0 then desired income will be less than national income meaning that…
Production will fall
When Y=Y0 the economy will be in…
Equilibrium (E0)
What are the two possible shifts of the AE function?
One is when the AE function if parallel to itself (parallel shift)
One is when there is a change in slope of the AE function
What determines the size of the change in national income?
The simple multiplier
What is the simple multiplier?
It is a ratio of the change in equilibrium national income to the change in autonomous expenditure that brought it about, calculated for a constant price level
What is the simple multiplier greater than?
It is greater than 1
