Macroeconomy: Goods & Services Market, Fiscal Policy Flashcards
Definition: Aggregate Output
Total quantity of Goods & Services produced or supplied in a economy in a given period
Definition: Aggregate Income
Total income received by all FOP in a given period
Consumption Function / Aggregate Expenditure
AE = Y = C + I + G + NX C: consumption of households I: investments of firms G: government spending NX: spending of RoW = Exports - Imports
Factors determining the expenditure of households
- higher income = higher spending and saving
- higher wealth = higher spending and saving
- lower interest rates = increase spending and may reduce saving
- expectations about future
Keynesian Consumption Function (KCF)
- amount of consumption at each level of income
C = C0 + cY
C0 = autonomous consumption cY = induced consumption (rises with disposable income)
Marginal Propensity to Consume (MPC) = c
- quantifies induced consumption
- proportion of additional income that an individual consumes
- increase in income comes with increase in consumption
- slope of KCF
Propensity to Consume
Proportion of disposable income which individuals spend on consumption
Equilibrium level of income and consumption at KCF
- intersection of KCF with 45° line
- each dollar earned is spend
- -> level of dissaving and saving is zero
Saving Function
S = -C0 + sY
-C0: proportion of income consumed
sY: proportion of income saved
- amount of saving is a function of income
Dissaving and Saving
Dissaving (decreases with rising income): Consumption > Income
Saving (more income = more saving): Consumption < Income
Maximum amount of dissaving
equals autonomous consumption
Types of investment (3)
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)
Determinants of Investment
- expected return from investments
- cost of capital (interest rates)
- taxation of returns
- availability of savings
- risk appetite of investors
Investments in our model
- function of interests
- relation between investment and interest rate is negative
- I = I0 (autonomous investment)
- Investment shifts KFC upwards (Y = C + I)
Saving = Planned Investment approach to equililbrium (S = I)
- -> planned aggregate expenditure = aggregate output (equilibrium) only when saving equals planned investment
- difference of saving to planned investment is unplanned inventory change
Role of financial markets in Saving = Planned Investment approach to equilibrium
- money from households to banks to firms
- leakage matches injection as long as all savings are loaned for fixed investments
Adjustment to Equilibrium (Saving = Planned Investment)
- 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
2 ways government can affect macroeconomy
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)
Fiscal policy
Changes in government purchases of goods and labor, taxes and transfer of payments to households with the objective of changing the economy’s growth
Monetary policy
Changes in the quantity of money in circulation to change economoy’s growth (interest target rate)
How does Government finance itself?
- taxes (income, capital gains, corporate)
- borrowing (government bonds)
- selling / renting assets
- printing money
Disposable Income / After tax income
Yd = Y - T
–> Income minus Net Tax Revenue
Net Tax Revenue
T = tY - T0
–> tax income minus transfer payments
Government budget
Document presenting the government’s proposed revenues and spending for a financial year, depends on tax income (T) and government expenditure (G)
Types of government budget
- balanced budget (G = T)
- surplus budget (G < T)
- deficit budget (G > T)
