Week 7 - Aggregate Expenditure Model Flashcards

1
Q

What is aggregate expenditure?

A

Refers to the total amount of spending in the economy (consumption, investment , gov purchases and net exports). Description of specific flows in a macro economy for a time period/

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2
Q

What does the AE model do?

A

Macroeconomic model focusing on the short-run relationship between total spending and real GDP.

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3
Q

Is the price level assumed to be constant in the AE model

A

yes

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4
Q

What are the 5 key variables impacting consumption

A

1) current disposable income
2) expected future income
3) household wealth
4) price level
5) interest rate

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5
Q

What are the assumptions about people in the AE model?

A

assumes people are rational, maxamising and self interested.

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6
Q

What is the permanent income hypothesis?

A

Asserts people spend at a level consistent with their expected long-term average income which would significantly weaken the impact of disposable income and expected income on consumption

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7
Q

Define wealth

A

refers to the accumulation of income in the form of assets.

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8
Q

What is the wealth effect?

A

Wealth can be drawn on to fund spending and make consumers more comfortable with spending, depending on the liquidity

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9
Q

Why is inflation important in the AE model?

A

inflation:

  • decreases the real value of wealth
  • leads to increasing demand for cash
  • causes changes in exchange rates and relative world prices
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10
Q

Impact of higher interest rates on consumption

A

Higher interest rates make money more costly and lowers consumption (particularly that financed by debt)

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11
Q

Formula for consumption

A

C = A + MPC + DI

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12
Q

What is the MP

A

marginal propensity to consume.
= slope of consumption function
= change in consumption / change in disposable income

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13
Q

What is autonomous consumption

A

autonomous consumption is spent regardless of disposable income (e.g. food and water)

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14
Q

Formula for disposable income

A

DI = national income (GDP) - net taxes

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15
Q

Formula for investment in AE model?

A

Depends on the level on actual investment, although, planned investment may be different due to expectations (inventories are goods that have been produced but not yet sold)

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16
Q

How are savings treated in the AE model?

A

All savings are converted into some form of business asset but some may sit idle for a period.

17
Q

What is planned I reliant on?

A

1) expectations of future profitability
2) interest rates
3) taxes
4) cash flows (profit = tr - tc)

18
Q

What are gov purchases?

A

includes net spending at a federal, state and local level

19
Q

What impacts net exports in AE model?

A

relative price levels - if inflation is lower than elsewhere, relative prices fall leading to falling imports and rising exports

relative growth rates - if our GDP rises faster, so does income. Some of this will be used on imports and nx falls.

Exchange rate - a depreciating dollar makes exports more competitive and nx rises

20
Q

What is the equilibrium condition in AE model?

A

Total output = total expenditure
45 degree line illustrates equilibrium and measures real national income against planned real aggregate expenditure. All point of macroeconomic equilibrium lie on this line.

21
Q

What happens in the AE model if AE is more than GDP

A

inventories are rising, gdp and employment are falling.

22
Q

What is the multiplier effect?

A

autonomous expenditure created a leveraging effect in which an incremental increase in spending yields a proportionately greater effect on GDP than the amount of spending

23
Q

What is the multiplier formula in AE model?

A

multiplier = change in equilibrium real GDP / change in autonomouts expenditure

= 1/ 1- MPC

24
Q

What happens if a firm is in a high inventory situation when a recession hits?

A

This is bad as inventory is not liquid and inventories will be increasing more are AE falls. The firm may reduce prices if its not perfectly competitive, reduce/stop production or dump (in extreme cases like GD)

25
Q

What does a higher MPC mean for consumpton

A

= larger multiplier and higher change in consumption (positive relationship)