Income and Expenditure Flashcards
What does disposable income equal? When disposable income changes what two categories are affected?
-Disposable income=Consumption+Private Savings
-When disposable income changes, the two categories that are affected are consumption and private savings. The difference is split between the two.
What is the formula for marginal propensity to consume? What does it show?
-MPC=Consumption/Disposable income.
-It shows that for each dollar of disposable income, how much your consumption increases.
What is the formula for marginal propensity to save? What does it show?
-MPS=Private Savings/Disposable income
-It shows for every extra dollar of disposable income you get, how much your income increases.
What is the aggregate consumption function?
-C=AC+MPC*YD
-C is aggregate consumption.
-AC is automonomous consumption.
-AC is the level of consumption that is not dependent on disposable income(YD) How much do people consume when income in the economy is 0. Some people will consume. That’s why AC acts as an intercept.
-YD is disposable income.
What two factors shift the aggregate consumption function?
1) Changes in future expected income
2) Changes in aggregate level of wealth
What is the life cycle hypothesis?
-Households plan their consumption over thier lifetime.
-So they try to smooth out their consumption over their lifetime by saving some of their current income during their peak earning years, and running down the wealth accumulated after retirement.
-People don’t want major fluctuations of consumption over the course of their life.
What are the two types of investment?
1) Planned Investment-the level of investments that businesses intended to undertake.
2) Unplanned Investment-unexpected changes in inventories.
What is the formula for planned investment? Which other formula does it equal?
-Planned investment=AI-d*i
-AI=Autonomous investment. Any factor that affects firms willingness to invest, other than interest rate.
-d=how sensitive is our investment to a change in interest rate?
-i=interest rate
-The formula for planned investment equals the demand for loanable funds formula.
What factors affect planned investment?
1) Interest Rate
-Given the fact that companies already have an idea of the ROI of investment, as interest rates rise, less firms find that the ROI is greater than interest rate. So planned investment falls.
2) Expected Future Real GDP
-The accelerator principle suggests an increase in expected future real GDP growth rate leads to an increase in planned investment.
-Firms need to invest now to meet the higher demand their products will generate in the future.
-Planned investment is positively related to the future real GDP growth.
When is inventory negative?
-If actual sales is greater than expected sales, firms have to deplete their inventories in order to meet higher than expected sales. Inventories will then drop.
What is the formula for actual investment?
-I=Planned Investment+Unplanned Investment
-I=[AI-d*i]+Unplanned Investment
What are the assumptions of the income-expenditure model?
1) Producers are willing to supply additional output at a fixed price. As long as there is a change in aggregate expenditure, there is a change in aggregate output. As long as there is demand, there is supply.
2) Interest rate is held fixed.
3) Government spending, taxes, and transfers are given.
4) Exports and imports are given.
Please note: These assumptions will be relaxed over the course
What is the formula for planned aggregate expenditure?
-Planned AE=C+I+G+X-IM
-Planned AE=(AC+MPCYD)+(AI-di)+G+X-IM
-Since YD=Y-T+TR, then Planned AE=[AC+MPC(Y-T+TR)]+(AI-di)+G+X-IM
-Rearrange the equation such that Planned AE=[AC+AI+G+X-IM-MPCT+MPCTR-di]+(MPCY).
-On the left side is the Autonomous Expenditure.
-So the equation can be rewritten as Planned AE=AE+MPC*Y
What is the formula for multiplier?
M=change in y/change in AE(Autonomous Investment)
Given a bunch of different information, what is the step to finding the equilibrium level of output in the income-expenditure model?
Step 1: Express the consumption function as a function of Y.
Step 2: Derive the planned expenditure, AE Planned function.
Step 3: Solve for the equilibrium level of output.
When is unplanned investment negative?
If planned expenditure is greater than actual expenditure, then demand for goods is greater than supply. Firms will find that sales shoot up unexpectedly. Not wanting to miss that opportunity, the firms will have to send the staff, go to the storage room, take the finished product, and put it on the shelf. But then firms will find their inventory drops. Then their “unplanned investment” will actually be negative.
