Theory of output, N & Y determination (10)

Question 1

Endogenous vs exogenous variable

Answer 1

endogenous = variable which affect other variables but is also affected by them. dependent.
exogenous = variable which affects other variables but is not affected by them. independent.

ex: Consumption and Y both affect each other and are affected by each other
while X will affect Y but X is not affected by Y. so it affects them but is not dependent of them. (exogenous)

Question 2

AE =

Answer 2

C + I+ G + X - M
C = consumption
I = fixed capital investment expenditure
G = current gov exp
X-M = export - import

Question 3

Aggregate Demand

Answer 3

Ad = willingness to consume + ability to spend
-force that drives econ’s engines

In this model for chapter 11 : AD = AE

Question 4

Willingness to consume

Answer 4

W = consumer confidence + interest rate (r)
-confidence: contagious. feeling/ emotional attitude
-interest rate : short term borrowing and deposit rate
**confidence rises and rates fall = more spending = boost in demand = growth in econ
**confidence falls & rate rise = less spending = decrease demand = no growth

Question 5

Willingness to consume = Marginal propensity to consume = MPC

Answer 5

change in C / change in Y

Question 6

in the SR flow of Consumption expenditure is influenced by 3 factors

Answer 6

1) variation in HDI
2) level of consumer confidence
3) variation interest rates

confidence + rate : influence willingness
HDI determines ability to spend

Question 7

John Maynard Keynes

Answer 7

shaping the rate of consumption and investment expenditure in the economy: his theory of the concept of Marginal propensity to consume (MPC) and save (MSPS) = willingness to pay

Question 8

The rate of interest

Answer 8

price of credit which also reflects the opportunity cost of consumption
- households split their income between saving and consumption. the higher the return on their saving, the less they will use their money to consume (higher opportunity cost of consumption)

Question 9

Wealth effect

Answer 9

when rates fall they cause the value of assets to rise which makes ppl feel wealthier = greater degree of confidence = people save less and spend more

Question 10

Personal savings

Answer 10

= spending power reserved for a future period
postponed consumption

Question 11

Consumption and personal saving function

Answer 11

C = a + bY
consumption = autonomous consumption (constant) + rate at which we spend the money (slope of the function) x household income per period

a = always positive, minimum amount to cover basic needs
b = bigger than 0 smaller than 1

the more you earn the more you spend

Question 12

MPC

Answer 12

change in consumption / change in income
= b
= slope of the function
= rate of spending
= willingness to spend

Question 13

personal saving function

Answer 13

Sp = Yd - C
Sp = Yd - (a + bY)
Sp = Yd -a -bY
Sp = -a + (1-b) Y

Yd = C + Sp

how much of their income households choose to spend (MPC) determines how much they will save (MPS)

So: MPC + MPS = 1

MPS = 1 - MPC = 1 - b

Question 14

Fixed capital investment expenditure (I)

Answer 14

spending on durable fixed assets such as plant buildings, engineering structures, machinery and equipment
3 types:
1) business capital invest. (BI)
2) public invest. (PI)
3) invest. in residential housing (HI)

I = BI + PI + HI

investment is essential for growth SR and LR and raising living standards

Question 15

Cash flow

Answer 15

undistributed profits (retained earnings) + CCA (capital cost allowance - depreciation)

Question 16

Business saving (Sb)

Answer 16

cash on hand (liquidity) + cash flow

Question 17

Cost of capital

Answer 17

direct cost such as the interest payments on the funds raised and the opportunity cost which is the income that is forgone by not applying it to an alternative use

Question 18

Rate of return

Answer 18

for an investment to make sense the rate of return must exceed the rate of interest it pays to finance

Question 19

The simple model

Answer 19

consumption and investment expenditure
AE = C + I
Y = C + I
when C + I are bigger than Y = level of production and income and employment will rise
when it is equal will stop rising at this intersection. equilibrium level. no tendency for the economy to either expand or contract further.
I = S equilibrium when total investment equals total savings

Question 20

current government expenditure (G)

Answer 20

consolidated expenditure of all three levels of government: municipal, provincial, federal
-government operating expenditures EX: supplies, heating, printing, salaries paid to civil servants
does not include transfer payments to households such as old age pensions

Question 21

Transfer payments

Answer 21

paid to households such as old age pensions, employment insurance, child tax benefit are not included in G

Question 22

Budgetary expenditures (BG)

Answer 22

current gov expenditure (G) + cap invest. expenditure (PI) + Gov transfer payments (TP) + interest on the public debt

Question 23

Marginal propensity to be taxed (MPT)

Answer 23

ratio of the change in government tax receipts to the change in the level of income
-known as the marginal tax rate
-change in gov tax / change in income Y
-effective MPT in Canada is around 0.35 & is the slope of the gov tax function

Question 24

Gov budget balance

Answer 24

T - BG
gov tax - budgetary expenditures
when T is bigger = we will have a budget surplus
when T is smaller = we budget deficit
when T- BG = 0 we have balanced budget

Question 25

Tax rate

Answer 25

rise in tax rate = reduce the total income that people earn in the SR
we pay more tax on our income it reduces our disposable income and reduces the amount we will spend to buy goods and services
-Reduce consumption = reduce aggregate demand = decrease in level of output, employment, and national income

Question 26

Trade surplus

Answer 26

when exports exceed imports
X - M bigger than 0

Question 27

Trade deficit

Answer 27

when exports fall short of imports
X - M smaller than 0

Question 28

Marginal propensity to import

Answer 28

MPM = change in import / change in Y = m

Question 29

When C, I, G, X increase

Answer 29

rise in output, employment, income

-but when the MPS MPT MPM rise = country output, employment and income fall

Question 30

AE bigger AS

Answer 30

aggregate expenditure bigger than supply = inventories fall, level of production (GDP), employment and income rise

Question 31

AE smaller than AS

Answer 31

inventories rise, level of prod, employment, income fall

Question 32

AE = AS

Answer 32

inventories remain constant, level of prod, employment and income remain constant

Question 33

Equilibrium level of income

Answer 33

Aggregate expenditure and supply approach

when AS = AE

AE= C + I + G + X - M

AS = Y = GDP

Question 34

injection leakages approach

Answer 34

injections = money which is spent during a given period in the econ but which was not generated during the same period within the econ (spending that comes out of our savings- from the past)
J = I + G + X

Leakages or withdrawals = money which is earned during a given period but not spent inside the econ during the same period.
Sum of savings, taxes and imports
L = S + T + M

Marginal propensity to withdraw
MPW = MPS + MPT + MPM = change in L / change in income Y

when J bigger than L = inventories fall, gdp, n, y rise
J smaller than L = inventories rise, gdp, n, Y fall
J = L = inventories constant, gdp, n, y constant equilibrium

Question 35

Inventory

Answer 35

inventory bc impossible to perfectly forecast the demand
inventory to sale ratio = total stock of inventory/ monthly sales

when drop in demand = undesired accumulation of inventories
firm will cut back production , reducing employment, income

Question 36

increase in G spending effect on the equi level of income

Answer 36

case of parallel shift
AE will move up parallel
J = I + G + X = will move up parallel

Question 37

increase tax rates on the equi level of income

Answer 37

rotational shift
same y intercept but rotate down AE

L = S + T + M will rotate up, same y intercept

Question 38

The multiplier effect

Answer 38

income multiplier K effect
every dollar of expenditure injected in the econ creates more than a dollar’s worth of output and income
k = change in Y / change in J is bigger than 1

income multiplier factor K by which every dollar spent gets multiplied in the process of income creation and is found by calculating ratio of change in income that results from the change in autonomous expenditure J

K = 1 / MPS + MPT + MPM
k = 1 / MPW

in Canada ranges between 1.6 and 2

k = 1 / 1- MPCd

MPCd = MPC - MPM = marginal propensity to consume domestically

Question 39

full employment level of income (Yf)

Answer 39

Ye = Yf = Potential GDP
Yf - Ye = GDP Gap
Expenditure gap = gdp gap / multiplier k

expenditure gap x multiplier k = gdp gap
change in AE X k = change in income

GDP gap will be on the x axes (GDP)
Expenditure gap will be on the y axes (AE, AS)

Question 40

determining level of income using algebra

Answer 40

1) MPC is slope of consumption function, MPM is slope of the import function
2) MPS = 1- MPC
3) find the saving function subtract C from Y. S = Y- C
4) find income multiplier k : K = 1/ 1- mpcd
MPCd = MPC - MPM (that we already have)
5) find income equi level Ye : set AS = AE
since AS = Y, set Y = AE and solve
Y = AE
Y = C + I + G + X - M
Ye = eg 800 billion