Week 1 - Part 2 Flashcards
(40 cards)
Draw Diagram (initially)
Draw Diagram (after increase consumption)
What is the equilibrium condition in the goods market and how is it derived?
The equilibrium condition in the goods market is represented by the equation Y = Z, where Y is production and Z is the demand for goods. This condition implies that production must be equal to the demand for goods. It’s derived by first defining the demand for goods (Z) as the sum of consumption (C), investment (I), and government spending (G). By substituting the expressions for C and I into Z, and then equating it to production (Y), we obtain the equilibrium condition.
What types of equations are used in models, as seen in this example?
Models use three types of equations: identities, behavioral equations, and equilibrium conditions. An identity is a definition, like the equation defining disposable income. A behavioral equation describes the behavior of economic agents, like the consumption function. An equilibrium condition, such as production equals demand, is used to determine the balance in a model.
How is equilibrium output determined in the goods market?
Equilibrium output in the goods market is determined by the equation Y = (c0 + I + G - c1T) / (1 - c1). This equation arises from rearranging the equilibrium condition to isolate Y. It shows that equilibrium output is a function of autonomous spending (c0 + I + G - c1T) and the multiplier (1 / (1 - c1)). Autonomous spending includes elements independent of output, while the multiplier amplifies the effect of changes in autonomous spending on output.
What is the multiplier effect and how does it work?
The multiplier effect is a concept in macroeconomics where a change in economic activity (like government spending or investment) leads to a greater than proportional change in total economic output. It occurs because an initial increase in spending leads to increased production, which then increases income and further boosts spending, creating a cycle of increasing economic activity. The multiplier is calculated as 1 / (1 - c1), where c1 is the marginal propensity to consume.
How does the economy adjust to changes in demand in the short run?
In the short run, the economy adjusts to changes in demand through a series of responses that gradually move it towards a new equilibrium. Initially, an increase in demand (like a rise in consumption or government spending) leads to higher production, which then increases income and further boosts demand. This process continues until the new equilibrium is reached. The speed of adjustment depends on factors like how quickly firms revise production schedules in response to changes in demand. The adjustment is not instantaneous and can take time, reflecting real-world dynamics.
What is the equilibrium equation in the goods market from the textbook and how is it represented?
The equilibrium equation from the textbook is Y = c0 + c1Y - c1T + I + G. This equation shows the balance in the goods market where production Y equals the sum of consumption c0, the product of the marginal propensity to consume and income c1Y, minus the product of the marginal propensity to consume and taxes c1T, plus investment I and government spending G.
How is the equilibrium output Y determined using algebra?
To determine equilibrium output Y algebraically, consumption dependent on income c1Y is moved to the left side to isolate Y, resulting in the equation: (1 - c1)Y = c0 + I + G - c1T. Dividing both sides by (1 - c1), the final form of the equation is Y = 1/(1 - c1) * [c0 + I + G - c1T]. This represents the level of output that is in equilibrium, meaning where production equals demand.
What does autonomous spending comprise in the equilibrium equation?
Autonomous spending comprises the components c0 + I + G - c1T in the equilibrium equation. This term includes c0, which is the level of consumption when income is zero, I which is investment spending, and G which is government spending, all considered independent of the current level of output. The component c1T is the adjustment for the impact of taxes on consumption.
What is the significance of the multiplier in the equilibrium equation?
The multiplier, represented by the term 1/(1 - c1), is significant in the equilibrium equation because it amplifies the effect of autonomous spending on equilibrium output. The multiplier’s value depends on the marginal propensity to consume c1, which reflects the portion of additional income that consumers spend. A higher c1, closer to 1, results in a larger multiplier effect.
How does an increase in autonomous spending lead to a change in equilibrium output?
An increase in autonomous spending, such as a rise in c0, leads to a greater than proportional increase in equilibrium output Y. For example, if c0 increases by $1 billion and c1 is 0.6, then the equilibrium output increases by a factor of the multiplier, which in this case would be 2.5, resulting in an additional $2.5 billion in output.
Can you explain the process of how the multiplier effect works step by step?
The multiplier effect works as follows: An increase in autonomous spending triggers an increase in demand. This leads to an increase in production, which results in an increase in income. The increase in income then leads to further increases in consumption and demand. This cycle continues until the new equilibrium is reached, with each round of increased income causing further increases in consumption and demand.
Why is the term c1T considered part of autonomous spending even though it is related to consumption?
The term c1T is considered part of autonomous spending because it represents the government’s tax policy, which is an autonomous decision, not directly influenced by the current level of income or output. While taxes reduce disposable income and affect consumption, their level is determined independently of the economy’s immediate performance. Therefore, the inclusion of c1T in autonomous spending adjusts for the effect of taxation policy on consumption, independent of the economy’s output.
How is production plotted as a function of income in the Keynesian cross?
Production is plotted on the vertical axis and income on the horizontal axis. They are assumed to be identically equal, so the line representing this relationship is a 45-degree line from the origin, where every dollar of income corresponds to a dollar of production. (draw diagram)
How is demand plotted as a function of income?
The demand equation Z = c0 + I + G - c1T + c1Y is simplified for graphing to Z = (c0 + I + G - c1T) + c1Y. Autonomous spending (c0 + I + G - c1T) is the intercept of the demand curve on the vertical axis. The slope of the demand curve, represented by ZZ, is the marginal propensity to consume c1, indicating that for every additional unit of income, consumption increases by c1 units. (draw diagram)
Where is the equilibrium point in the goods market found?
Equilibrium is found where the demand curve intersects the 45-degree line representing production equals income. At this intersection point “A”, the amount of goods produced Y equals the demand for goods Z. To the left of point A, demand exceeds production; to the right, production exceeds demand. At point A, demand and production are equal. (draw diagram)
What does the demand depend on according to the Keynesian cross model?
Demand depends on autonomous spending and income. This indicates that overall demand is influenced by a baseline level of spending, which is independent of current income levels (autonomous spending), and the level of income through induced consumption. (draw diagram)
What does the slope of the demand curve indicate?
The slope of the demand curve is less than 1, since the marginal propensity to consume c1 is between 0 and 1. This means that demand does not increase one-for-one with income, as consumers spend only a fraction c1 of an additional dollar of income on consumption. (draw diagram)
What does point A represent in the Keynesian cross model graph?
Point A represents the initial equilibrium where the economy’s production and income are equal, indicated by the intersection of the demand curve (ZZ) with the 45-degree line.
What is the effect of an increase in autonomous spending (c0) on the Keynesian cross graph?
An increase in autonomous spending (c0) by $1 billion shifts the consumption line upward, resulting in a new demand curve labeled ZZ’, positioned $1 billion above the original demand curve at all income levels.
How does the shift in the demand curve affect the economy’s equilibrium?
The shift in the demand curve due to a $1 billion increase in autonomous spending creates a new, higher equilibrium point A’, where both production and income have increased to a level Y’, which is greater than the original level Y.
What illustrates the multiplier effect on the Keynesian cross graph?
The multiplier effect is illustrated by the larger increase in equilibrium output (Y’ - Y) compared to the initial increase in autonomous spending. This is reflected in the movement from point A to A’ on the graph.
Describe the process of successive rounds of spending due to the multiplier effect.
The multiplier effect triggers successive rounds of spending: an initial increase in demand leads to increased production (point B), which increases income and leads to further demand and production increases (points C to D), continuing until the new equilibrium (point A’) is reached.
