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Macro Economics > Topic 2 - Spending in the economy > Flashcards

Topic 2 - Spending in the economy Flashcards

1
Q

2.01 - In a simple aggregate expenditure model what assumptions are made (7)?

A
  • Closed economy
  • No government
  • All savings are personal
  • Depreciation & net Aust income are zero
  • Businesses make investment decisions
  • Real interest rates influence investment
  • Price inflexibility (fixed).
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2
Q

2.02 - What is a closed economy?

A

It is an economy where both the product and financial markets of the economy are fully isolated from the rest of the world.

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3
Q

2.03 - What is a private closed economy?

A

Where there is no explicit contribution by the government to either the product or financial markets.

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4
Q

2.04 - What is price-wage inflexibility?

A

It is that all prices including wages and interest rates are inflexible, especially over the short term and do not adjust to remove disequilibria over this period.

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5
Q

2.05 - What is the final assumption (not covered) that we make when using a simple aggregate expenditure model?

A

That the economy has a substantial amount of excess productive capacity and unemployed labour.

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6
Q

2.06 - Using the assumptions of an aggregate expenditure model, an increase in aggregate expenditures will increase what?

A

Real output and employment (not price)

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7
Q

2.07 - What are included in aggregate expenditures?

A

The sum of:

  • expenditures on consumption (C)
  • investment (I)
  • government purchases (G)
  • net exports (NX)
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8
Q

2.08 - What are the tools of aggregate expenditures theory?

A

The consumption schedule, savings schedule and the investment schedule.

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9
Q

2.09 - What is DI and what is it equal to?

A

Disposable income equals consumption plus saving. Households consume most of their DI.

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10
Q

2.10 - What is the consumption schedule?

A

It is a schedule of the income-consumption relationship.

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11
Q

2.11 - What does the consumption schedule show?

A

It shows the various amounts households plan or intend to consume at various possible levels of disposable income.

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12
Q

2.12 - What is the savings schedule?

A

It is a schedule of the income-saving relationship.

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13
Q

2.13 - What does the savings schedule show?

A

It shows the various amounts households plan or intend to save at various possible levels of disposable income.

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14
Q

2.14 - What is break-even income?

A

It is the level of income at which consumption expenditure exactly equals household income.

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15
Q

2.15 - What is APC?

A

The average propensity to consume (APC) is the fraction or percentage of any given total income that is consumed. APC = consumption/income

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16
Q

2.16 - What is APS?

A

The average propensity to save (APS) and is the fraction or percentage of any total income that is saved. APS = saving/income

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17
Q

2.17 - What does APC + APS equal?

A

1 because consumption + saving = DI and so income/income would equal 1.

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18
Q

2.18 - What is MPC?

A

Marginal propensity to consume and it is the ratio of the change in consumption to the change in income that brought about the consumption change. Thus the MPC represents the fraction of each additional (or marginal) dollar of income that will be used for consumption expenditures.

MPC = change in consumption / change in income

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19
Q

2.19 - What is MPS?

A

Marginal propensity to save and it is the ratio of the change in saving to the change in income that brought about the saving change, Thus the MPS represents the fraction of each additional (or marginal) dollar of income that will be directed to saving.

MPS = change in saving / change in income

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20
Q

2.20 - What does MPC + MPS equal? and what are the assumptions for their value?

A
  1. It is assumed that the MPC and MPS are constant at 0.75 and 0.25.
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21
Q

2.21 - How are MPC and MPS shown in a diagram?

A

MPC is the slope of Consumption (C) and MPS is the slope of Spending (S)

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22
Q

2.22 - What are the non-income determinants of consumption and saving that may cause households to consume more or less at each possible level of DI?

A
  • wealth
  • price level
  • expectations
  • consumer indebtedness
  • taxation rates
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23
Q

2.23 - What is a change in the amount consumed? and how is it drawn?

A

It is caused by a change in the level of DI and is a movement along the consumption or saving slope.

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24
Q

2.24 - What is a change in the consumption schedule and how is it drawn?

A

A change in the consumption schedule is caused by one or more of the non-income determinants changing. It causes the consumption or saving slope to shift up or down

25
Q

2.25 - Are the consumption and savings schedules generally stable and how do they shift?

A

Yes they are, except when government deliberately act to shift them. A shift (increase) in saving, will mean a shift (decrease in consumption and vice versa).

26
Q

2.26 - What is investment?

A

Expenditure on new plant, capital equipment, machinery etc.

27
Q

2.27 - What are the two basic determinants of investment?

A

1) the expected rate of net profits that businesses hope to realise from investment spending and
2) the real rate of interest.

28
Q

2.28 - What is the expected rate of net profit (when referring to it as a determinant of investment)?

A

This is that

  • businesses are motivated by profit and
  • businesses invest if they expect a net profit from this investment
29
Q

2.29 - What is the real rate of interest (when referring to it as a determinant of investment)?

A

It is:

  • the inflation adjusted cost associated with borrowing money
  • equals nominal interest rate minus the inflation rate
  • and acknowledges that investment projects will only be undertaken if net expected profit rates exceed the real interest rate.
30
Q

2.30 - What is the investment demand schedule?

A

It is a schedule of the investment-interest rate relationship.

31
Q

2.31 - What does the investment demand schedule show?

A

It shows the cumulative level of investment demanded at various possible levels of the interest rate.

32
Q

2.32 - How is the investment demand curve drawn and why?

A

It is downwards sloping and shows the inverse relationship between the interest rate (the financial price of investing) and the aggregate quantity of capital goods demanded.

33
Q

2.33 - What are the non-interest determinants of investment demand?

A
  • costs
  • business taxes
  • technological change
  • inventory on hand
  • expectations
34
Q

2.34 - How does the stock of capital goods on hand shift the investment demand curve?

A

Excess productive capacity tends to shift the investment demand curve to the left. A relative scarcity of capital goods shifts it to the right.

35
Q

2.35 - What ‘expectations’ could effect the investment demand curve?

A
  • political climate
  • foreign influence
  • population growth
  • stock market conditions
    Optimism shifts the curve right, whereas pessimism shifts it left.
36
Q

2.36 - What does the investment schedule show?

A

It shows the amounts that business firms as a group plan to invest at each of the various possible levels of income.

37
Q

2.37 - Why is business investment autonomous to the level of current income?

A

Because it is geared to long-term profit expectations, which are influenced by technological progress and population growth

38
Q

2.38 - What is induced investment?

A

Where the level of income rises causing the excess capacity to disappear. Firms then become inclined to add to their stock of capital goods.

39
Q

2.39 - How is an autonomous investment schedule drawn on a graph? and how is an induced investment schedule drawn?

A

Autonomous is a vertical line because it doesn’t change based on the level of Real GDP. Induced increases because it does change based on the level of Real GDP.

40
Q

2.40 - Describe the stability of consumption and the stability of investment

A

Consumption (especially non-durables) is relatively stable, but investment is relatively unstable.

41
Q

2.41 - Why is investment unstable?

A
  • Durability (capital goods are durable so postponable)
  • Irregularity of innovation (doesn’t happen regularly)
  • Profit variability
  • Variable expectations
42
Q

2.42 - What are the two approaches to determining the equilibrium levels of output and income?

A
  • Expenditures - output approach (C+I = AE)

* Leakages - injections approach (S=I)

43
Q

2.43 - What is the equilibrium output?

A

It is the level of total output that exists when the flow of income created by the production of the output gives rise to a level of total expenditure sufficient to clear the product market of that output.

44
Q

2.44 - What is the aggregate expenditures - output approach to income determination?

A

It is the model that uses the relationship between aggregate expenditures and output to determine the equilibrium level of national income. So in a two sector economy AE = C+I

45
Q

2.45 - When does equilibrium GDP occur? and how is this shown on a graph?

A

Where the total output (measured by GDP) and aggregate expenditures (C+I) for a two sector economy are equal. It is shown as the point where the aggregate expenditures line intersects the 45 degree line.

46
Q

2.46 - What is the leakages-injections approach to income determination?

A

It is the model that uses the required relationship between leakages from and injections back into the expenditure flow to determine the equilibrium level of national income.

47
Q

2.47 - Is saving an injection or leakage, and why?

A

Saving is a leakage, and is that part of income which is not consumed and therefore put back into the economy.

48
Q

2.48 - Is investment an injection or leakage, and why?

A

Investment is an injection, and is put back into the economy.

49
Q

2.49 - What will occur if the leakage of savings exceeds the injection of investment?

A

Then C+I will fall short of GDP and this level of GDP will be too high to be sustainable. Only where S=I (where the leakage of saving is exactly offset by the injection of investment) will aggregate expenditures equal the domestic output.

50
Q

2.50 - What are the two components of investment?

A
  • Planned investment ( the level of investment, including inventory investment, that business plan to make within the specified period).
  • Unplanned investment (unintended changes in the level of business inventories - this acts as a balancing item)
51
Q

2.51 - What is actual investment?

A

It is the sum of planned and unplanned investment (which by definition is equal to saving) over a period

52
Q

2.52 - What are the levels of investment at equilibrium?

A

There is no unplanned investment or disinvestment in inventories to drive the GDP downward or upward.

53
Q

2.53 - What is planned saving?

A

It is the level of savings that households intend to achieve over a specified period.

54
Q

2.54 - What is actual saving?

A

It is the level of saving achieved by households based on the incomes they receive and the MPS.

55
Q

2.55 - How is equilibrium achieved when there is a difference between saving and planned investment?

A
  • This difference causes difference between the production and spending plans of the economy
  • The mismatch results in unintended investment or disinvestment in inventory
  • This revision of production plans will re-establish equilibrium.
56
Q

2.56 - When is the level of GDP stable?

A

When savings and planned investment are equal.

57
Q

2.57 - Is GDP stable?

A

No it is seldom stable and is characterised by cyclical fluctuations.

58
Q

2.58 - What does shifts in the AE curve due to changes in autonomous expenditure cause?

A

New equilibrium levels of output (GDP), but how much depends on the size of the expenditure multiplier.

Macro Economics (7 decks)

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