Chapter 6

Question 1

What does the subscript “a” indicate when added to the letters that represent the various categories of expenditure? (C= consumption, I = investment, G = government purchases, X-IM = net exports)

Answer 1

It indicates the desired expenditure in these categories

Question 2

What does desired expenditure mean?

Answer 2

“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 3

What does the equation of desired aggregate expenditure represent?

Answer 3

It represents the sum of desired or planned spending on domestic output by households, firms, governments, and foreigners

Question 4

What is the equation for desired aggregate expenditure?

Answer 4

AE = C + I + G + (X − IM)

Question 5

What are the elements of aggregate expenditure that do not change systemically with national income called?

Answer 5

Autonomous expenditures

Question 6

What are the components of aggregate expenditure that do change systemically in response to changes in national income called?

Answer 6

Induced expenditures

Question 7

What are the assumptions of the simplest short-run macro model?

Answer 7

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
the price level is constant.

Question 8

What is the equation of disposable income?

Answer 8

Disposable income = household income - taxes

Question 9

What is saving?

Answer 9

It is disposable income not spent on consumption

Question 10

What is the consumption function?

Answer 10

It is the relationship between desired consumption expenditure and all the variables that determine it

Question 11

What is desired consumption determined by?

Answer 11

It is determined by disposable income, wealth, interest rates, and expectations about the future

Question 12

What is the equation for Income?

Answer 12

Income = Consumption expenditures + Savings

Question 13

What is the equation for APC?

Answer 13

APC = C/Yd
APC = desired consumption / level of disposable income

Question 14

What is the equation for APS?

Answer 14

APS = S/Yd
APS = desired saving / disposable income

Question 15

What does APC + APS equal to?

Answer 15

APC + APS = 1

Question 16

What is the equation for mpc?

Answer 16

mpc = ΔC/ΔYd
mpc = change in desired consumption / change in disposable income

Question 17

What is the equation for mps?

Answer 17

mps = ΔS/ΔYd
mps = change in desired saving / change in disposable income

Question 18

What does the slope of the Savings function equal to?

Answer 18

mps

Question 19

What does the slope of the Consumption function equal to?

Answer 19

mpc

Question 20

What does mpc + mps equal to?

Answer 20

1

Question 21

What does APC stand for?

Answer 21

Average propensity to consume

Question 22

What does mpc stand for?

Answer 22

Marginal propensity to consume

Question 23

What does the constant slope of the consumption function show?

Answer 23

That the MPC is the same at any level of disposable income

Question 24

What do households decide?

Answer 24

How much to consume and how much to save

Question 25

What does APS mean?

Answer 25

Average propensity to save

Question 26

What does mps mean?

Answer 26

Marginal propensity to save

Question 27

Why does APC + APS = 1?

Answer 27

the fractions of income consumed and saved must account for all income because all disposable income is either spent or saved

Question 28

Why does MPC + MPS = 1?

Answer 28

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

Question 29

In what situations does the consumption function shift upward?

Answer 29

1. Increase in wealth 2. Decrease in interest rates 3. Increase in optimism about the future

Question 30

In what situations does the consumption function shift downward?

Answer 30

1. Decrease in wealth 2. Increase in interest rates 3. Decrease in optimism about the future

Question 31

In what situations does the saving function shift downward?

Answer 31

1. Increase in wealth 2. Decrease in interest rates 3. Increase in optimism about the future

Question 32

In what situations does the saving function shift upward?

Answer 32

1. Decrease in wealth 2. Increase in interest rates 3. Decrease in optimism about the future

Question 33

What are the 3 categories of investment?

Answer 33

Inventory accumulation Residential construction New plant and equipment

Question 34

What are the characteristics of investment expenditure?

Answer 34

It is the most volatile component of GDP and is strongly associated with aggregate economic fluctuations

Question 35

What are the determinants of desired investment expenditure?

Answer 35

Real interest rate Changes in level of sales Business confidence

Question 36

What cost is associated with investement?

Answer 36

Opportunity cost

Question 37

What does a higher real interest rate lead to?

Answer 37

A higher opportunity cost of investment

Question 38

What do higher levels of sales lead to?

Answer 38

Larger stock of inventories

Question 39

What does does a change in the rate of sales do?

Answer 39

It leads to temporary bouts of investment/disinvestment in inventories

Question 40

What does optimism in desired investment and business confidence lead to (expectations about the future)?

Answer 40

Increased desired investment

Question 41

What does pessimism in desired investment and business confidence lead to (expectations about the future)?

Answer 41

Decreased desired investment

Question 42

What does the aggregate expenditure (AE) function relate?

Answer 42

It relates the level of desired aggregate expenditure to the level of actual income

Question 43

What is aggregate expenditure equal to in the absence of government and international trade?

Answer 43

It is equal to desired consumption (or consumption function) plus desired investment (or investment function) AE = C + I

Question 44

What is the slope of the AE function?

Answer 44

It is the marginal propensity to consume

Question 45

What occurs when desired aggregate expenditure exceeds actual income (value of production)?

Answer 45

Inventories fall and there is pressure for all national income to rise (need to increase production)

Question 46

What occurs when desired aggregate expenditure is less than actual income (value of production)?

Answer 46

Inventories rise and there is pressure for actual national income to fall (need to reduce production)

Question 47

When does the equilibrium level of national income occur?

Answer 47

When desired aggregate expenditure equals national income

Question 48

If actual Y < Y0 then desired income will exceed national income meaning that...

Answer 48

Output will rise

Question 49

If actual Y > Y0 then desired income will be less than national income meaning that...

Answer 49

Production will fall

Question 50

When Y=Y0 the economy will be in...

Answer 50

Equilibrium (E0)

Question 51

What are the two possible shifts of the AE function?

Answer 51

One is when the AE function if parallel to itself (parallel shift) One is when there is a change in slope of the AE function

Question 52

What determines the size of the change in national income?

Answer 52

The simple multiplier

Question 53

What is the simple multiplier?

Answer 53

It is a ratio of the change in equilibrium national income to the change in autonomous expenditure that brought it about, calculated for a constant price level

Question 54

What is the simple multiplier greater than?

Answer 54

It is greater than 1