consumption function Flashcards
what is the equation that shows the connection between AE, O and Y?
O=Y=AE
what is the consumption function model based upon?
the relationship between the level of disposable income received by households and the level of consumption and savings
what is the equation for the simple consumption function?
Y=C+S
what does the 45 degree line represent?
it shows all points where planned expenditure is equal to planned income.
why is the 45 degree line drawn?
to show all the points of equilibrum, along this line output is always equal to expenditure
what does equilibrum mean?
the level of income, output and spending in the economy is in balance
what does the break even amount mean?
where all income is spent on consumption and nothing is saved
when is savings positive?
at higher levels of income because C is less than the income
when is savings negative?
at lower levels of income when C exceeds income
what is the general formula?
c=a+bY
what does a stand for?
autonomous consumption (when Y=0)
what does b stand for?
MPC
what is the MPC?
marginal propensity to consume - the fraction of any change in income that is spent on consumption
how is MPC calculated?
change in C / change in Y
how is MPS calculated?
it is whatever is not consumed
what is the savings function equation?
S=a+(1-b)Y
what does a stand for in the savings function?
the amount of savings required to be spent to fund consumption when Y=)
what does (1-b) stand for?
1-MPC or MPS and is the slope of the SF
what is dissaving?
when Y is not great enough to fund C you are spending your savings
when will S cross the x axis?
when C=Y at the break even point when C intersects the 45 degree line
what is the APC?
the overall proportion of Y that has been consumed at a particular level of Y
what is the APC equation?
APC=C/Y
why does the APC fall as income rises?
because as Y rises autonomous consumption represents a smaller and smaller proportion of your Y
what is APS?
the overall proportion of Y that has been saved at a particular level of Y
what is the APS equation?
APS=S/Y
why does APS rise when Y rises?
savings begins to represent a larger proportion of Y
what are the assumptions when the financial sector is added?
- levels of investment are constant across all levels of Y
- the level of AE must now be equal to consumption plus investment so AE=C+I
- C rises by the level of I
- equilibrum occurs where S and I intersect
what is the equilibrum level of income called?
Ye
what happens if the level of income is either above or below the equilibrum level?
planned spending will not equal output and firms inventories will change, signalling them to either increase or decrease production. the economy will move towards equilibrum
when income is greater then equilibrum and output is greater then aggregate expenditure how will the economy move to equilibrum?
- firms experience a surplus
- inventories rise
- firms cut production and employment
- output falls, income falls, expenditure falls
- continue until Ye
when income is below equilibrum, investment exceeds savings and expenditure is greater than output how will the economy move towards Ye?
- shortage of goods
- inventories fall
- firms increase production and employment
- output and income rise
- continue until Ye
