2nd Half Flashcards
Ch.13 - Ch.16 (42 cards)
Consumption
Household spending on final goods and services.
- Single largest component of GDP.
Consumption Function
A curve plotting the level of consumption associated with each level of income.
-Visual summary of household spending.
-Upward sloping
Marginal Propensity to Consume
Fraction of each extra dollar of income that households spend on consumption.
Describes how consumption responds to a change in income
Saving and Dissaving
Saving:
-Putting unspent income in bank or investing
-Paying debt
Dissaving
-Your loans
Consumption Smoothing
Maintaining a steady or smooth path for your consumption spending over time.
Permanent Income / Hypothesis
Your best estimate of your long-term average income.
Hypothesis: the idea that consumption is driven by permanent income rather than current.
-Economic fluctuations matter only to a the extent that affect a permanent income.
5 Insights of Relationship Between Consumption and Income
- Temporary change = small change in consumption.
- Permanent change = large change in consumption.
- Anticipated change = no change in consumption.
- Learning about a future income change = change in consumption.
- It’s hard to forecast changes in consumption.
Credit Constraints
Limits on how much you can borrow.
-Banks are often reluctant to lend money when a loan isn’t backed by collateral.
Hand-to-Mouth Consumers
Spend their income as they receive it.
-MPC is 1
-Do not smooth consumption
-Their consumption reflects their current income not permanent.
5 Hybrid Insights about Relationship Between Consumption and Income
- Small for smoothers, large for hand-to-mouth
- Large change from both
- No change for smoothers and large change for hand-to-mouth
- Large for smoothers but no change to hand-to-mouth
- Depends on the share of hand-to-mouth consumers.
4 Factors that Shift Consumption Curve
- Real Interest Rates
- Expectation
- Taxes
- Wealth (but not a change in income)
Substitution and Income Effect
Substitution: high interest rate reduces current consumption.
Income: high interest:
- rate boosts income for lenders -> higher consumption.
- decreases income for borrowers –> reduce consumption
Types of Investment
- Business Investment
- Inventories
- Housing Investment
Compounding
Accumulation of money over time, as you earn interest (or return) on both principal and accrued interest (or return).
Discounting
Converting future values into their equivalent present values using a discount rate.
-Should reflect on: opportunity cost (time), inflation, risk (uncertainty).
Discount Rate (r)
The interest rate you use in discounting should be the rate of return you could get from investing your funds in your next best alternative at an equivalent level or risk.
Perpetuity and Annuity
Perpetuity: a stream of equal and equally spaced out payments occurring indefinity.
Annuity: steam of equal and equally spaced out payments occurring for a period of time.
User Cost of Capital and Depreciation Rate
Extra cost associated with using one more machine next year. “Rental Cost”
Depreciation Rate (d): proportion of an investment’s remaining productive capacity you lose each year due to depreciation.
4 Investment Shifters
- Technological Advances
- Expectations
- Corporate Taxes
- Lending Standards and Cash Reserves
Market for Loanable Funds
Market for the funds used to buy, ren, or build capital.
-It brings together savers who want to lend their funds and investors who want to borrow those funds.
Supply Shifters of Loanable Funds
- Changes in Personal Saving Rates
- Government Saving Shifts Due to Changing Budget Surpluses and Deficits
- Foreign Saving Shifts Due to Global Shocks
The Financial Sector
Any firm that manages with transactions, capital flow, and risk.
-Why is it important?
3 Key Pillars of Financial Sector
- Banks
- The Bond Market
- The Stock Market
What Banks Do
- Pool savings from many savers
- Spread the risk of lending money across many borrowers
- Solve information problems
- Provide payment services.
- Create long-term loans from short-term deposits
