WEEK 5 Flashcards
why do busts and booms involve chain reactions?
households and firms are mutually interdependent
marginal propensity to save
fraction of an additional dollar of disposable income that is saved
marginal propensity to consume
fraction of an additional dollar of disposable income that is spent on consumption
total increase in real GDP from $x increase in aggregate spending =
with original increase in real GDP being $x, increasing spending in multiple rounds equation?
equation for the change in real GDP and autonomous change in aggregate spending (AAS)
equation for the multiplier
the larger the MPS, the…
smaller the multiplier
current disposable income
income after taxes are paid and government transfers are received
consumption function
equation showing how an individual household’s consumer spending varies with household’s disposable income
c = a + (MPCxYd)
c = household’s consumer spending
Yd = household’s disposable income
a = constant; autonomous consumer spending
autonomous consumer spending
what a household would spend even with 0 income
consumption function graph
aggregate consumption function
- relationship for the economy as a whole between aggregate disposable income and aggregate consumer spending
- C = A + (MPC x YD)
- same variables as other function, just aggregate
what causes shifts in the consumption function?
- Shift upwards: increase in real (aggregate) wealth, increase in real (aggregate) wealth, increase in consumer confidence
- Shift downwards: decrease in these variables
planned investment spending
investment spending that businesses intend to undertake in given period
what is planned investment spending determined by?
- interest rates: as IRs rise, businesses stop investing because fewer projects with higher rate of return
- expected real GDP: if firms expect sales to increase, they will invest in more capital (etc.) to keep up with demand
- current level of production capacity: if firms have more than enough production capital, storage space, etc. then won’t invest in more
accelerator sprinciple
higher rate of growth in real GDP leads to higher planned/investment spending
inventories
stocks of goods held to satisfy future sales
inventory investm ent
value of change in total investories held in an economy in a given period
unplanned inventory investment
unplanned changes in inventories occurring when actual sales are more or less than expected
actual investment spending
sum of planned and unplanned inventory investment
equation: I = Iunplanned + Iplanned
assumptions in the income-expenditure model
changes in overall spending lead to changes in aggregate output
interest rate is fixed
taxes, government transfers and government purchases = 0
imports + exports = 0
- AEplanned = C + Iplanned
- AEplanned = planned aggregate spending = total amount of planned spending in the economy
aggregate planned spending graph
- Iunplanned > 0
- Iunplanned < 0
- firms have overestimated sales so too much addition to inventories
- firms have underestimated sales so will be unintended decrease in inventories
GDP equation in terms of planned expenditure
GDP = AEplanned + Iunplanned
income-expenditure equilibrium
- when aggregate output equal to planned aggregate spending
- intersect occurs when Iunplanned = 0
why are changes in inventories considered leading indicator of future economic activity?
- when planned spending doesn’t equal output shows up in inventory changes
- if drop the assumption that APL is fixed then a decrease in APL leads to an increase in ASplanned
- leads to multiplier process that increases equilibrium expendicture and income
