Macroeconomy: Goods & Services Market, Fiscal Policy

Question 1

Definition: Aggregate Output

Answer 1

Total quantity of Goods & Services produced or supplied in a economy in a given period

Question 2

Definition: Aggregate Income

Answer 2

Total income received by all FOP in a given period

Question 3

Consumption Function / Aggregate Expenditure

Answer 3

AE = Y = C + I + G + NX
C: consumption of households
I: investments of firms
G: government spending
NX: spending of RoW = Exports - Imports

Question 4

Factors determining the expenditure of households

Answer 4

• higher income = higher spending and saving
• higher wealth = higher spending and saving
• lower interest rates = increase spending and may reduce saving
• expectations about future

Question 5

Keynesian Consumption Function (KCF)

Answer 5

• amount of consumption at each level of income

C = C0 + cY

C0 = autonomous consumption
cY = induced consumption (rises with disposable income)

Question 6

Marginal Propensity to Consume (MPC) = c

Answer 6

• quantifies induced consumption
• proportion of additional income that an individual consumes
• increase in income comes with increase in consumption
• slope of KCF

Question 7

Propensity to Consume

Answer 7

Proportion of disposable income which individuals spend on consumption

Question 8

Equilibrium level of income and consumption at KCF

Answer 8

• intersection of KCF with 45° line
• each dollar earned is spend
• -> level of dissaving and saving is zero

Question 9

Saving Function

Answer 9

S = -C0 + sY

-C0: proportion of income consumed
sY: proportion of income saved
- amount of saving is a function of income

Question 10

Dissaving and Saving

Answer 10

Dissaving (decreases with rising income): Consumption > Income
Saving (more income = more saving): Consumption < Income

Question 11

Maximum amount of dissaving

Answer 11

equals autonomous consumption

Question 12

Types of investment (3)

Answer 12

1) Purchase of capital goods (computer, robots..)
2) Ownership of dwellings (exception to households do not invest)
3) Change in inventories (goods produced, but not yet sold)

Question 13

Determinants of Investment

Answer 13

• expected return from investments
• cost of capital (interest rates)
• taxation of returns
• availability of savings
• risk appetite of investors

Question 14

Investments in our model

Answer 14

• function of interests
• relation between investment and interest rate is negative
• I = I0 (autonomous investment)
• Investment shifts KFC upwards (Y = C + I)

Question 15

Saving = Planned Investment approach to equililbrium (S = I)

Answer 15

• -> planned aggregate expenditure = aggregate output (equilibrium) only when saving equals planned investment
• difference of saving to planned investment is unplanned inventory change

Question 16

Role of financial markets in Saving = Planned Investment approach to equilibrium

Answer 16

• money from households to banks to firms

- leakage matches injection as long as all savings are loaned for fixed investments

Question 17

Adjustment to Equilibrium (Saving = Planned Investment)

Answer 17

• if output (income) > planned aggregate expenditure –> unplanned inventory increase –> warehouses fill up –> firms reduce production (economy towards equilibrium, maybe recession)
  Y > Planned AE
  and vice versa

Question 18

2 ways government can affect macroeconomy

Answer 18

1) fiscal policy (spending and taxation)
2) monetary policy (central bank and money supply)

Government controls some variables directly through government decisions (e.g. tax rates, unemployment compensation), but some variables are a result of the state of the economy (e.g. tax revenue, unemployment rate)

Question 19

Fiscal policy

Answer 19

Changes in government purchases of goods and labor, taxes and transfer of payments to households with the objective of changing the economy’s growth

Question 20

Monetary policy

Answer 20

Changes in the quantity of money in circulation to change economoy’s growth (interest target rate)

Question 21

How does Government finance itself?

Answer 21

• taxes (income, capital gains, corporate)
• borrowing (government bonds)
• selling / renting assets
• printing money

Question 22

Disposable Income / After tax income

Answer 22

Yd = Y - T

–> Income minus Net Tax Revenue

Question 23

Net Tax Revenue

Answer 23

T = tY - T0

–> tax income minus transfer payments

Question 24

Government budget

Answer 24

Document presenting the government’s proposed revenues and spending for a financial year, depends on tax income (T) and government expenditure (G)

Question 25

Types of government budget

Answer 25

• balanced budget (G = T)
• surplus budget (G < T)
• deficit budget (G > T)