Chapter 6

Question 1

What does desired mean?

Answer 1

It is what consumers and firms would like
to purchase, given their real-world constraints of income and market prices.

Question 2

Difference between autonomous and induced?

Answer 2

autonomous is like a constant in the formula, it is not related to changes in national income, while induced is closely related to changes in national income

Question 3

Assumptions of simplest short-run macro model

Answer 3

• 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

Question 4

Describe disposable income, its importance in the model and its use

Answer 4

In the simplest theory, consumption is determined primarily by
current disposable income (YD).
Disposable Income: is the amount of income households receive
after deducting what they pay in taxes and adding what they receive
in transfers.
Two possible uses of disposable income:
* consumption (C) or saving (S)

Question 5

Factors influencing desired consumption

Answer 5

Key factors influencing desired consumption:
* Disposable income
* Wealth
* Interest rates
* Expectations about future income

Question 6

Write the consumption function

Answer 6

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

Question 7

Describe the consumption function graph

Answer 7

• slope less than one
• break even level of income is when it touches the 45 degree line
  Axes are Yd (disposable income) and C

Question 8

Explain the marginal propensity to consume

Answer 8

change in consumption for a given change in disposable income
MPC=change in C/ change in Yd
its the consumption function slope

Question 9

what is APC

Answer 9

totalt consumption divided by total disposable income

Question 10

WHat is MPS and APS

Answer 10

same as MPC but for saving

Question 11

Write the rules for sums of APC and APS and MPC and MPC

Answer 11

APC + APS = 1
MPC + MPS = 1

Question 12

What causes shifts in consumption and savings functions?

Answer 12

• D wealth
• D interest rate
• D expectations

Question 13

What is special about desired investment?

Answer 13

Investment expenditure is the most volatile component of GDP:
changes in investment expenditure are strongly associated with short-run fluctuations.
Three important determinants of aggregate investment expenditure are:
* the real interest rate
* changes in the level of sales
* business confidence

Question 14

Explain the relationship between desired investment and real interest rate

Answer 14

The real interest rate is the opportunity cost for:
* investment in new plants and equipment
* investment in inventories
* investment in residential construction
Thus, all three components of desired investment expenditure are
negatively related to the real interest rate, other things being equal

Question 15

How do change in sale affect investment

Answer 15

The higher the level of production and sales, the larger the desired stock of inventories:
changes in the rate of sales cause temporary bouts of investment in inventories

Question 16

How business conf affect investment

Answer 16

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

Question 17

If its volatile and affected by all thoses things, then why is investment autonomous in the model?

Answer 17

• Autonomous is different than constant.
• This is a simplifying assumption but one can think that investment is taken for future benefit, and thus not affected by the current level of GDP.

Question 18

Describe the AE function

Answer 18

The AE function:
* relates desired aggregate expenditure to actual national income
* We mean real as opposed to nominal variables.
In the absence of government and international trade, desired aggregate expenditure is:
AE = C + I

Question 19

What is the slope of the AE function?

Answer 19

The MPS, but S stands for spend, in the chapter 5 model, its simply the MPC, its the change in AE for a given change in National income

Question 20

Explain the equilibrium national income

Answer 20

Assumption: Firms are able and willing to produce any amount of output that is demanded of them and without changing prices.
The equilibrium level of national income occurs where desired aggregate expenditure equals actual national income.

AE = Y

Question 21

What determines the equilibrium level of national income

Answer 21

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

Question 22

The difference between desired saving and desired investment is always equal to the difference between actual national income and
desired aggregate expenditure, show this

Answer 22

S - I = W
Y – C – I = W
Y – AE =W
The economy is in equilibrium when desired investment equals desired saving

Question 23

What are the two types of shifts in the AE function

Answer 23

1. The AE function can shift parallel to itself
   - Remember the effect of: D wealth, D interest rate,
   D expectations, D sales
2. The slope of the AE function can change
   - Change the marginal propensity to spend (z).
   - In this simple model: z = MPC.

Question 24

3 important propositions from our simple
model of national income determination:

Answer 24

1. Rise in AE for all levels of Y à shifts AE up à
   Increases equilibrium national income.
2. Fall in AE for all levels of Y à shifts AE down à
   Reduces equilibrium national income.
3. An increase in the marginal propensity to spend (z) à steepens
   the AE curve à
   Increases equilibrium national income

Question 25

What is the simple multiplier

Answer 25

The multiplier is a measure of the size of the change in equilibrium Y
that results from a change in autonomous expenditure.