Midterm 1: Chapter 12 pages 370-394 Flashcards
Aggregate Expenditure Model
A macroeconomic model that focuses on the short run relationship between total spending and real GDP; ASSUMES PRICE LEVEL IS CONSTANT
in any particular year the level of GDP is determined mainly by
level of aggregate expenditure
John Maynard Keynes
Wrote “The General Theory of Employment, Interest and Money” - analyzed relationship between AE and GDP
What were the four components of aggregate expenditure identified by Keynes
- Consumption (C) spending by households on goods and services
- Planned Investment (I) spending of firms on capital goods, research and development
- Government purchases (G) spending by local, state and federal gov on goods and services
- Net Exports (NX) imports - exports
what are inventories
Goods that have been produced but not yet sold
What’s included in investment spending
Changes in inventories, spending on machinery, equipment, office buildings, factories
When will actual investment be greater than planned investment
when there’s an unplanned increase in inventories
When will the actual investment be less than planned investment
when there’s an unplanned decrease in inventories
When will actual investment and planned investment be equal
No unplanned changes in inventories
When does equilibrium occur in AE model
when total spending, or aggregate expenditure, equals total production/GDP
When aggregate expenditure is greater than GDP
spending in economy is greater than total amount of production, causing inventories to decline, which will result in more employment and a GDP increase
When aggregate expenditure is less than GDP
spending in economy is less than production, causing increase in inventories, nd resulting in less GDP and employment
what is the largest component of the aggregate expenditure
consumption
Five most important variables that determine level of consumption
- Current disposable income,
- household wealth
- expected future income
- the price level
- the interest rate
what happens as disposable income goes up
spending goes up to AE increase
what happens when wealth increases
price of one’s house or stocks increase, causing an increase in spending and AE
what happens when price level increases
the real value of your wealth decreases so spending decreases
What happens when interest rates are high
the reward to save is increased, causing less spending and more saving,
what is real interest rate equal to and what is its effect on durable goods
the real interest rate is equal to the nominal interest rate minus inflation, and the higher it is less people consume on durable goods
what is Marginal Propensity to Consume (MPC)
the slope of the consumption function on the graph; it’s how much consumption changes when disposable income changes
what is equation for MPC
(change in consumption / change in disposable income)
Equation for disposable income
national income - net taxes
What is National income equal to
GPD = Disposable income + net taxes
also Consumption + Savings + taxes
Marginal Propensity to save (MPS)
how much savings change when disposable income goes up
What always equals 1 when taxes are constant
MPC + MPS
