Short-Run Macro Model Flashcards
What is the short-run macro model?
It is a macroeconomic model that explains how changes in spending can affect real GDP in the short run
What does spending depend on in the short-run?
on income
What does income depend on in the short-run?
Spending
Instances where consumption spending will increase…
-when disposable income rises
-when wealth rises
-when the interest rate falls
-households become more optimistic about the future
How do you find disposable income?
Long Equation: Income -Tax payments + Transfers received
Short Equation: income - net taxes
How can you described the relationship between consumption spending and disposable income?
- As disposable income rises, consumption spending rises
- this relationship is roughly linear
- it is also known as the consumption function
What is the consumption function (def.)
A positively sloped relationship between real consumption spending and real disposable income
What is autonomous consumption spending? (def.)
- The part of consumption spending that is independent of income
- you can find it by finding the vertical intercept of the consumption function ( b = ACS)
What is the marginal propensity to consume? (MPC) (def.)
- The MPC is the slope of the consumption function: the change in consumption divided by the change in disposable income OR the amount by which consumption spending rises when disposable income rises by one dollar
Consumption Function (eq.)
C = A + B x (Disposable income)
where:
C: consumption spending
A: vertical intercept of the consumption function
B: slope of the consumption function (MPC)
What are some limitations of the consumption function?
While this functions shows us the value of consumption at each level of disposable income, it does not tell us the value of consumption spending at each level of income
What is one assumption we make about the consumption function?
That net taxes are independent of income
Consumption - income line
- A line showing aggregate consumption spending at each level of income or GDP
- same slope as the consumption function (MPC)
-vertical intercept = a - MPC x T (because of taxes)
What will happen if income increases and net taxes remains unchanged?
- disposable income will rise
- consumption spending will rise
- movement rightward along the consumption - income line
What will happen if there is a decrease in net taxes?
- disposable income will rise @ each level of income
- consumption spending will rise @ any income level
- shift upward of the consumption - income line
An increase in autonomous consumption will shift the consumption-income line upward because…
of an increase in household wealth, interest rates decrease, or if households become more optimistic about the future
We will move along the consumption-income line when…
A change in income causes consumption spending to change
We will see a shift in the consumption-income line when…
a change in anything else besides income causes consumption spending to change
The consumption- Income line will shift upward when:
net taxes decrease as transfers will increase and taxes will decrease
or when autonomous consumption increases, as household wealth increase, the interest rate decreases, or there is greater optimism
The Consumption-Income line will shift downward when:
Net taxes increases, as transfer will decrease and taxes will increase
or autonomous consumption decreases as household wealth will decrease, interest rate increases, or there is greater pessimism
What are the components of total spending?
-Consumption spending by households (C)
-Planned investment spending (Ip)
-government purchases (G)
-Net exports (NX)
What are some assumptions we make when looking at the components of total spending? In specific Ip, G, and NX
Ip, G, and NX are determined outside of our analysis, and have fixed values
Investment Spending (Ip)
-plant and equipment purchases by business firms and new home construction
-not included: changes in inventories
Government purchases
- all of the goods and services that government agencies - federal, state, and local - buy during the year
Net Exports (NX)
Exports minus imports
Aggregate expenditure (AE)
- some of spending by households, business firms, the government, and foreigners
-ON final goods and services produced in the United States
= C + Ip + G + NX
What is the relationship between income and spending?
- it is circular: spending depends on income, and income depends on spending
When income increases (by change in GDP)
- AE increases by change in AE = MPC x change in GDP
What happens when AE is less than GDP…
Output will decline in the future, thus any level of output at which AE is less than GDP cannot be the equilibrium GDP
When AE > GDP…
output will rise in the future… thus any level of output at which AE > GDP cannot be the equilibrium
Equilibrium GDP in the short run…
the level of output at which AE = GDP
If there is a change in inventories during any period…
it will always equal output minus aggregate expenditure
change in inventories = GDP - AE
A 45 Degree line…
is the translator line, which allows us to measure any horizontal distance as a vertical distance instead
Any output level where AE line lies below the 45 degree line…
AE < GDP
- inventories will grow
- reduce output in the future
Any output level where AE line lies above the 45 degree line…
AE > GDP
-inventories will decline
-they will increase their output in the future
Equilibrium GDP..
is the output level at which the AE line intersects the 45 degree line
- if firms produce this output level their inventories will not change, and they will be content to continue producing the same level of output in the future
If we are in Short -Run equilibrium and yet have abnormally high unemployment
-the aggregate expenditure line too low to create an intersection at full-employment output
-cyclical unemployment is caused by insufficient spending
-as long as spending remains low, production will remain low and unemployment will remain high
In short-run equilibrium..
the economy can overheat because spending is too high, and as long as spending remains high, production will exceed potential output and unemployment will be unusually low
Change in GDP = Expenditure Multiplier x Change in Ip.
What is the expenditure multiplier?
1/ (1-MPC)
where the amount by which equilibrium real GDP changes, as as a result of a one-dollar difference change either of the following:
- autonomous consumption
-investment spending
-government purchases
-or net exports
