Income and Expenditure Flashcards
What is the Aggregate Expenditure Equation? What does it Represent?
The Aggregate Expenditure (AE) is the total of all planned spending in the economy
C+I+G+NX
What is the consumption equation? What does each part of the consumption equation represent? Give Examples.
c=a+bYD
C- Consumption Expenditure
a-is a positive constant. This is the intercept. We call it Autonomous Consumption Expenditure. This means it is consumption unrelated to our income.
Example: Even if you have no job, you will still spend a certain amount on food and rent. That is your autonomous consumption
b-A positive fraction between 0 and 1. It is the slope of the line and is also known as the Marginal Propensity to consumer (MPC)
Yd- Disposable income: This is the income after paying taxes, which is what we can either spend or save
Induced Expenditure- Expenditure that is determined byt national income levels. This is opposite of autonomous expenditure and is represented by bYd in the formula above.
What is Average Propensity to Consume (APC). What is the formula?
The APC is consumption divided by the level of disposable income. This does change at different levels of income. It can be greater, less than or equal to 1
What is Marginal Propensity to Consume (MPC). What is the formula?
Change in C/ Change in YD
The MPC is the slope of the consumption function line. It is the change in consumption expenditure caused by a change in income. This does not change at different levels of income. It must always be between 0 to 1
Marginal propensity to consume (MPC)—How much people consume rather than save when there is a change in income. This can also be explained as the portion of each new dollar of disposable income that consumers will spend rather than save.
Amount of additional consumption resulting from a change in income
What Shifts Consumption? What happens when autonomous expenditure changes?
If the autonomous expenditure changes, the vertical intercept will change causing the entire line to shift up or down
A fall in interest rates usually shifts the consumption line up because it is cheaper to take loans to buy durable goods (like cars)’
If people have optimistic expectations of the future consumption line will shift up
An increase in household wealth will shift the consumption line up. Wealth is assets and investments so if you are doing well, you don’t need to save as much and you can spend more
Why is MPC+MPS=1
Since a dollar of extra disposable income leads either to extra planned consumption or extra planned saving we can say that
MPC+MPS=1
Savings: What is average propensity to save? What is the APS formula?. What is Marginal Propensity to Save? What is the MPS formula? What is the relationship between MPC and MPS?
Average Propensity to Save (APS)- This is the savings divided by the level of disposable income. This does change at different levels of income. It can be less than, greater than or equal to 1
APS: S/YD
Marginal Propensity to Save (MPS)- This is the change in savings divided by the change in disposable income. This does not change at different levels of income. It is always between 0 and
1
How much people save rather than consume, when there is a change in income. This can also be explained as the portion of each new dollar of disposable income that consumers will save rather than spend
Amount of additional savings resulting from a change in income
MPS=Change in S/Change in YD or (1-MPC)
Investment Expenditure: What is investment Expenditure? Does it depend on income? What are the three ways investment is impacted? List and explain all three. Draw the investment graph.
Investment Expenditure does not depend on our income so its completely autonomous. It is very volatile and gets affected by 3 things:
The Real Interest Rate
Changes in the level of sales
Business confidence
Real interest Rate: As the real interest rate increases, it is more expensive for firms to take loans so investment expenditure falls. Higher real interest also means there is a higher opportunity cost of investment because firms could be earning high returns on interest-earning assets (like bonds), which again makes investment in a new factory less attractive.
Change in Sales: The higher the level of sales, the larger the desired stock of inventories, so higher investment
Business Confidence: If firms are optimistic about the future state of the economy they will take on more investment projects, so investment will rise.
Explain Government Expenditure? Does it depend on our income? What does it not include? Draw a graph.
Government expenditure (purchases) does not depend on our income so it is autonomous
It does not include transfer payments which are payments, which are payments made to citizens that are unrelated to currently produced goods/services
Example: Transfer payments include pension paid retired people or welfare payments made to low income/ unemployed people
T=ty
T= total taxes
t=tax Rate
What is formula for disposable income
YD= Y-T
What is the Disposable Income formula? If Y=1000 and the tax rate is 30% or 0.3, what is disposable income?
the disposable income is 1000- 0.3(1000)=700
Explain exports in the Aggregate Expenditure model. Are they determined by our income? Provide an example, Draw a graph?
Exports
Exports are also autonomous. Our exports are not determined by our national income.
Instead, they depend on income levels in other countries, This means that only things like changes in income levels of other countries and changes in preferences of other countries will affect how much we export.
Example: If there is a recession in Japan, our exports to Japan will decrease.
Explain imports. What expenditure is this apart of? What is the Marginal Propensity to Import (MPI)? Explain each part in the MPI formula? What is the import function, draw a graph?
Imports are a part of domestic expenditure. Like consumption expenditure, imports rise as income levels increase (positive relationship).
Marginal Propensity to Import (m) – this is the change in imports caused by a $1 change in national income. It is also called MPI or MPM.
Example: If m is 0.4, then that means that as income levels rise by $1, imports increase by $0.40.
IM: Total expenditure on imports
m - the Marginal Propensity to Import. This is the slope of the import function line. It is also called MPM or MPI
Y- national income
What is the equation for net exports? Draw a graph
NX=X-IM
Explain Keynesian Multiplier
The amount by which an increase in spending will impact the total aggregate demand. Example, let’s say the government increases spending by 1 million dollars. An economy acts as a circular flow that initial 1 million dollars leads to an increase in household incomes of 1 million dollars, that increase in household income will lead to an increase in consumption and increase in savings. A dollar spent is a dollar earned which will be spent again, and earned again. That proportion that is spent is determined by the MPC
Interdependence principle: Spending depends on income, income depends on production, production depends on spending
Any changes in spending (C,I,G, NX) will be multiplied by the multiplier * times throughout the economy
Higher MPC, the higher the value of the keynesian multiplier, any change in spending will lead to larger increases in consumer spending as income is earned by households.
