MACRO- Output and Aggregate Demand Flashcards
What is Potential Output ?
Potential Output is the economy′s output when inputs are fully employed (at a sustainable level), this isn’t the maximum that you could ever produce, i.e. you could produce more by getting workers to stay massively over time but thats against workers rights.
the output when every market in
the economy is in long-run equilibrium
Everyone that wants to work, at the equilibrium wage rate is working
Machines are being utilised, not sitting around idly when they could be used to make profit.
Can there be unemployment at potential output?
Potential output allows for some equilibrium unemployment as some will not want to work at the equilibrium wage rate
Also, in a constantly changing economy, some people
are temporarily between jobs (frictional unemployment)
The consumption function
Shows aggregate consumption demand (consumption of households across an economy) dependent on the level of aggregate income.
C= A+ cY
What does the lower case c represent in the consumption function C=A+cY
Marginal propensity to consume
the fraction of each extra pound of disposable
income that households wish to consume
Using consumption function C=A+cY what do consumers do if income is zero?
If Y=0, they still consume A (autonomous consumption) as these are the bare necessities, but they dissave (spend their savings, to cosume A, so they save the amount -A PG 629
marginal propensity to save MPS
Using C= A+ cY it is 1-c, the fraction of each extra pound of disposable
income that households wish to save
Investment demand?
firms′ desired or planned additions to physical capital
(factories and machines) and to inventories
What is short run equilibrium (in words and what it looks like on a graph)
We’re in the short run so wages an prices are fixed. Output produced is equal to the level of Aggregate demand (Aggregate demand equals SR aggregate supply)
why does the level of investment equal level of saving in equilibrium?
Saving is the proportion of income that isn’t devoted to consumption (not including the gov or net exports)
Since Y=C+I (when C and I are at the right levels), the only part of the income not spent on consumption is invested, so S=I
Y=C+S in equilibrium
Aggregate demand
Planned spending on consumption (by households) and investment demand (by firms) , also planned government spending and net exports
C+I+G+(X-M)
The Multiplier and an example of how it works
The proportion to which actual output changes from an initial increase in aggregate demand.
e.g. increase in demand for computers means increase in C, but then also means increase in labour demand, for people toc reate the computers and I, to get machines to build the computers. Since these firms have more profit, the shareholders have more disposable income so will increase their spending C, which may trigger this whole multiplier effect again.
1/MPS= 1/1-MPC (remember both MPS AND MPC are below zero, so the multiplier is above 1
paradox of thrift
An autonomous change in consumption (increase in amount spent on consumption even when Y is 0, so AD has a parallel shift upwards ) means that people are saving a lower fraction of their income at every income level.
People would assume this means savings overall fall, but it stays the same as the increase in AD brought about by the rise in C (through the multiplier means people are saving a lower proportion , of a higher income, so the effect of a lower savings rate is offset.
(Investment levels were unchanged and since I=S in equilibrium savings had to be unchanged too)
autonomous
Spending or investment that doesn’t vary with income, it would be required even at an income of 0
Inflationary Gap
the amount by which the actual aggregate demand exceeds ‘aggregate supply
