Short-Run Macro Model

Question 1

What is the short-run macro model?

Answer 1

It is a macroeconomic model that explains how changes in spending can affect real GDP in the short run

Question 2

What does spending depend on in the short-run?

Answer 2

on income

Question 3

What does income depend on in the short-run?

Answer 3

Spending

Question 4

Instances where consumption spending will increase…

Answer 4

-when disposable income rises
-when wealth rises
-when the interest rate falls
-households become more optimistic about the future

Question 5

How do you find disposable income?

Answer 5

Long Equation: Income -Tax payments + Transfers received

Short Equation: income - net taxes

Question 6

How can you described the relationship between consumption spending and disposable income?

Answer 6

• As disposable income rises, consumption spending rises
• this relationship is roughly linear
• it is also known as the consumption function

Question 7

What is the consumption function (def.)

Answer 7

A positively sloped relationship between real consumption spending and real disposable income

Question 8

What is autonomous consumption spending? (def.)

Answer 8

• The part of consumption spending that is independent of income
• you can find it by finding the vertical intercept of the consumption function ( b = ACS)

Question 9

What is the marginal propensity to consume? (MPC) (def.)

Answer 9

• The MPC is the slope of the consumption function: the change in consumption divided by the change in disposable income OR the amount by which consumption spending rises when disposable income rises by one dollar

Question 10

Consumption Function (eq.)

Answer 10

C = A + B x (Disposable income)

where:

C: consumption spending
A: vertical intercept of the consumption function
B: slope of the consumption function (MPC)

Question 11

What are some limitations of the consumption function?

Answer 11

While this functions shows us the value of consumption at each level of disposable income, it does not tell us the value of consumption spending at each level of income

Question 12

What is one assumption we make about the consumption function?

Answer 12

That net taxes are independent of income

Question 13

Consumption - income line

Answer 13

• A line showing aggregate consumption spending at each level of income or GDP
• same slope as the consumption function (MPC)
  -vertical intercept = a - MPC x T (because of taxes)

Question 14

What will happen if income increases and net taxes remains unchanged?

Answer 14

• disposable income will rise
• consumption spending will rise
• movement rightward along the consumption - income line

Question 15

What will happen if there is a decrease in net taxes?

Answer 15

• disposable income will rise @ each level of income
• consumption spending will rise @ any income level
• shift upward of the consumption - income line

Question 16

An increase in autonomous consumption will shift the consumption-income line upward because…

Answer 16

of an increase in household wealth, interest rates decrease, or if households become more optimistic about the future

Question 17

We will move along the consumption-income line when…

Answer 17

A change in income causes consumption spending to change

Question 18

We will see a shift in the consumption-income line when…

Answer 18

a change in anything else besides income causes consumption spending to change

Question 19

The consumption- Income line will shift upward when:

Answer 19

net taxes decrease as transfers will increase and taxes will decrease

or when autonomous consumption increases, as household wealth increase, the interest rate decreases, or there is greater optimism

Question 20

The Consumption-Income line will shift downward when:

Answer 20

Net taxes increases, as transfer will decrease and taxes will increase

or autonomous consumption decreases as household wealth will decrease, interest rate increases, or there is greater pessimism

Question 21

What are the components of total spending?

Answer 21

-Consumption spending by households (C)
-Planned investment spending (Ip)
-government purchases (G)
-Net exports (NX)

Question 22

What are some assumptions we make when looking at the components of total spending? In specific Ip, G, and NX

Answer 22

Ip, G, and NX are determined outside of our analysis, and have fixed values

Question 23

Investment Spending (Ip)

Answer 23

-plant and equipment purchases by business firms and new home construction
-not included: changes in inventories

Question 24

Government purchases

Answer 24

• all of the goods and services that government agencies - federal, state, and local - buy during the year

Question 25

Net Exports (NX)

Answer 25

Exports minus imports

Question 26

Aggregate expenditure (AE)

Answer 26

- some of spending by households, business firms, the government, and foreigners -ON final goods and services produced in the United States = C + Ip + G + NX

Question 27

What is the relationship between income and spending?

Answer 27

- it is circular: spending depends on income, and income depends on spending

Question 28

When income increases (by change in GDP)

Answer 28

- AE increases by change in AE = MPC x change in GDP

Question 29

What happens when AE is less than GDP...

Answer 29

Output will decline in the future, thus any level of output at which AE is less than GDP cannot be the equilibrium GDP

Question 30

When AE > GDP...

Answer 30

output will rise in the future... thus any level of output at which AE > GDP cannot be the equilibrium

Question 31

Equilibrium GDP in the short run...

Answer 31

the level of output at which AE = GDP

Question 32

If there is a change in inventories during any period...

Answer 32

it will always equal output minus aggregate expenditure change in inventories = GDP - AE

Question 33

A 45 Degree line...

Answer 33

is the translator line, which allows us to measure any horizontal distance as a vertical distance instead

Question 34

Any output level where AE line lies below the 45 degree line...

Answer 34

AE < GDP - inventories will grow - reduce output in the future

Question 35

Any output level where AE line lies above the 45 degree line...

Answer 35

AE > GDP -inventories will decline -they will increase their output in the future

Question 36

Equilibrium GDP..

Answer 36

is the output level at which the AE line intersects the 45 degree line - if firms produce this output level their inventories will not change, and they will be content to continue producing the same level of output in the future

Question 37

If we are in Short -Run equilibrium and yet have abnormally high unemployment

Answer 37

-the aggregate expenditure line too low to create an intersection at full-employment output -cyclical unemployment is caused by insufficient spending -as long as spending remains low, production will remain low and unemployment will remain high

Question 38

In short-run equilibrium..

Answer 38

the economy can overheat because spending is too high, and as long as spending remains high, production will exceed potential output and unemployment will be unusually low

Question 39

Change in GDP = Expenditure Multiplier x Change in Ip.

Question 40

What is the expenditure multiplier?

Answer 40

1/ (1-MPC) where the amount by which equilibrium real GDP changes, as as a result of a one-dollar difference change either of the following: - autonomous consumption -investment spending -government purchases -or net exports