chapter 21

Question 1

what does desired mean with regards to expenditure?

Answer 1

“Desired” expenditure is not just a list of what consumers and firms would buy if they had no constraints on their spending—it is much more realistic than that.

Desired expenditure is what consumers and firms would like to purchase, given their real-world constraints of income and market prices.

Question 2

def/form. desired aggregate expenditure

Answer 2

The sum of desired or planned spending on domestic output by
households, firms, governments, and foreigners is desired aggregate
expenditure

AE = C + I + G + (X - IM)

Question 3

def. autonomous expenditures

Answer 3

Elements of expenditure that do not change systematically with national income

Question 4

def. induced expenditure

Answer 4

Any component of expenditure that is systematically related to
national income

Question 5

what are the 3 main assumptions of the simplest short-run macro model?

Answer 5

• there is no trade with other countries—that is, the economy we are studying is a closed economy;
• there is no government—and hence no taxes; and
• the price level is constant

Question 6

what is consumption determined by in the simplest theory?

Answer 6

primarily by current disposable income (Yd)

Question 7

def. disposable income

Answer 7

is the amount of income households receive after deducting what they pay in taxes and adding what they receive in transfers

Question 8

what are the two possible uses of disposable income?

Answer 8

consumption (c)

savings (S)

Question 9

What are the 4 key factors influencing desired consumption?

Answer 9

• Disposable income
• Wealth
• Interest rates
• Expectations about future income

Question 10

simplest consumption function

Answer 10

C = a + b *YD

**Holding constant other determinants of desired consumption, an increase in disposable income is assumed to lead to an increase in desired consumption

**slope of the simple consumption function (b) is less than 1

Question 11

marginal propensity to consume

Answer 11

The marginal propensity to consume (MPC) relates the change in desired consumption to the change in disposable income that brings it about.

MPC = change in C/ change in YD

**slope of the consumption function

Question 12

average propensity to consume (APC)

Answer 12

equal to total consumption divided by total disposable income

APC= C/Yd

Question 13

marginal propensity to save (MPS)

Answer 13

relates the change in desired saving to the change in disposable income that brings it about.

MPS= change in S/ change in Yd)

**slope of the saving function

Question 14

average propensity to save (APS)

Answer 14

equal to total desired saving divided by total disposable income

APS= S/Yd

Question 15

APC + APS = _____

Answer 15

1
-because all disposable income is either spent or saved, it follows that the fractions of income consumed and saved must account for all income

Question 16

MPC + MPS= _____

Answer 16

1

-the fractions of any increment to income consumed and saved must account for all of that increment

Question 17

if consumption function shifts upward, the saving function must shift __________

Answer 17

downward

Question 18

what is the most volatile component of GDP?

Answer 18

investment expenditure

Question 19

what are changes in investment expenditure are strongly associated with ____________

Answer 19

short-run fluctuations

Question 20

what are the 3 important determinants of aggregate investment expenditure are:

Answer 20

1. the real interest rate
2. changes in the level of sales
3. business confidence

Question 21

the real interest rate is the opportunity cost for what three things?

Answer 21

1. investment in new plants and equipment
2. investment in inventories
3. investment in residential construction

Question 22

all three components of desired investment expenditure are _______ related to the real interest rate

Answer 22

negatively

Question 23

the higher the level of production and sales, the _________ the desired stock of inventories

Answer 23

larger

**changes in the rate of sales cause temporary bouts of investment in inventories

Question 24

what happens when business confidence improves?

Answer 24

firms want to invest now
so as to reap future profits

**business confidence and consumer confidence may feed off of one another

Question 25

T or F: desired investment is autonomous, unaffected by changes in national income

Answer 25

true **simplifying assumption but one can think that investment is taken for future benefit, and thus not affected by the current level of GDP

Question 26

T or F: desired investment is constant

Answer 26

false, its autonomous

Question 27

the AE function description

Answer 27

- relates desired aggregate expenditure to actual national income - we mean real as opposed to nominal variables

Question 28

desired aggregate expenditure function:

Answer 28

AE= C + I

Question 29

marginal propensity to spend

Answer 29

z= change in AE/ change in Y *slope of the AE function Marginal propensity to spend (z) is the amount of extra total expenditure induced when national income raises by $1. Marginal propensity to consume (MPC) is the amount of extra consumption expenditure induced when households disposable income rises by $1

Question 30

what is an assumption when considering equilibrium national income

Answer 30

Firms are able and willing to produce any amount of output that is demanded of them and without changing prices

Question 31

where does the equilibrium level of national income occur?

Answer 31

where desired aggregate expenditure equals actual national income AE = Y

Question 32

If desired aggregate expenditure exceeds actual output:

Answer 32

* what is happening to inventories? | * there is pressure for output to rise

Question 33

if desired aggregate expenditure is less than actual output:

Answer 33

* what is happening to inventories? | * there is pressure for output to fall

Question 34

what is equilibrium condition?

Answer 34

Y= AE(Y) **Equilibrium national income is that level of national income where desired aggregate expenditure equals actual national income

Question 35

the difference between desired saving and desired investment is always equal to the difference between ________ and _________

Answer 35

actual national income and desired aggregate expenditure S - I = W Y – C – I = W Y – AE =W

Question 36

when is the economy in equilibrium with regards to desired investment and saving?

Answer 36

The economy is in equilibrium when desired investment equals desired saving

Question 37

What are the two kinds of shifts that can occur with the AE function?

Answer 37

1. AE function can shift parallel to itself - -effect of changes in: wealth, interest rate, expectations, sales 2. the slope of the AE function can change - -change the marginal propensity to spend (z) - -z= MPC

Question 38

What are the two important propositions from the simple model of national income determination? What is a third general proposition?

Answer 38

1. rise in AE for all levels of Y --> shifts AE up --> increases equilibrium national income 2. Fall in AE for all levels of Y --> shifts AE down --> reduces equilibrium national income 3. an increase in the marginal propensity to spend (z) --> steepens the AE curve --> increases equilibrium national income

Question 39

what is the simple multiplier?

Answer 39

change in Y/ change in A = 1 /1-z -where z is the marginal propensity to spend out of national income and change in A is the change in autonomous expenditure

Question 40

what does it mean that the multiplier exceeds 1?

Answer 40

the change in autonomous expenditure increases | equilibrium national income by a multiple of the initial change in autonomous expenditure.

Question 41

describe how economic fluctuations can be self-fulfilling prophecies

Answer 41

Households and firms base their desired investment and consumption partly on their expectations of the future: --> changes in expectations can lead to real changes in the current state of the economy

Question 42

what is an example of an economic fluctuation being a self-fulfilling prophecy

Answer 42

* imagine that firms feel optimistic about the future * this increases their desired investment, shifting up the AE curve * this increases Y, justifying the initial optimism