Ch 25 Flashcards
(27 cards)
Great Depression
Available resources are unemployed
Public’s willingness or ability to spend declines
A decrease in spending leads to lower production
Laid-off workers reduce their spending
Insufficient spending to support the normal level of production
Conventional economic policy of the 1920s and 1930s would not solve this problem
John Maynard Keynes revolutionized economic thought and public policy
The General Theory of Employment, Interest, and Money (1936) is his best-known work
Problem was explaining why economies kept a recessionary gap for long periods
Aggregate spending is too low for full employment
Stabilization policies use government spending or taxes to substitute for spending in other sectors
Technology has reduced menu costs
Bar codes and scanners reduce costs of changing prices in the store
Online surveys
Internet mechanisms for setting price
■ eBay ■ Online retailers
Other costs remain
■ Competitive analysis ■ Deciding the new prices
■ Informing consumers
Planned aggregate expenditure (PAE)
total planned spending on final goods and services
Four components of planned aggregate expenditure
Consumption (C) by households Investment (I) is planned spending by domestic firms on new capital goods Government purchases (G) are made by federal, state, and local governments Net exports (NX) equals exports minus imports
Planned Aggregate Expenditure (PAE)
We assume that actual spending equals planned spending for
Consumption
Government purchases of final goods and services
Net exports
PAE = C + I^P + G + NX
Consumption (C) accounts for two-thirds of total spending
Powerful determinant of planned aggregate expenditure
Includes purchases of goods, services, and consumer durables, but not new houses which are investment
Rent is considered a service
C depends on
disposable income, (Y – T)
The consumption function
an equation relating planned consumption (C) to its determinants, notably disposable income (Y –T)
C bar = C (bar) + (mpc) (Y – T), where
C is autonomous consumption spendingmpc is the change in consumption for a given change in disposable income
0 < mpc < 1
Autonomous consumption
is spending not related to the level of disposable income
A change in C bar shifts the consumption function
The wealth effect
the tendency of changes in asset prices to affect household’s wealth and thus their consumption spending
This effect is included in C
Autonomous consumption also captures the effects of interest rates on consumption
Higher rates increase the cost of using credit to purchase consumer durables and other items
Marginal propensity to consume (mpc)
is the increase in consumption spending when disposable income increases by $1
mpc is between 0 and 1 for the economy
If households receive an extra $1 in income, they spend part (mpc) and save part
(Y – T) is disposable income
Output less net taxes (taxes minus transfers)
Main determinant of consumption spending
Two dynamic patterns in the economy
Declines in production lead to reduced spending
Reductions in spending lead to declines in production and income
Consumption is the largest component of PAE
Consumption depends on output, Y
PAE depends on Y
Planned Expenditure Example
PAE = C + IP + G + NX C = C + mpc (Y – T) PAE = C + mpc (Y – T) + IP + G + NX
Suppose that planned spending components have the following values
C bar = 620 mpc = 0.8 T = 250 IP = 220 G = 330 NX = 20
PAE = 620 + 0.8 (Y – 250) + 220 + 330 + 20 PAE = 960 + 0.8 Y
Planned aggregate expenditure has two parts
Autonomous expenditure, the part of spending that is independent of output
$960 in our example
Induced expenditure, the part of spending that depends on output (Y)
0.8 Y in our example
Short-run equilibrium is the level of output at which planned spending is equal to output
No change in output as long as prices are constant
Our equilibrium condition can be written
Y = PAE
