WEEK 5

Question 1

why do busts and booms involve chain reactions?

Answer 1

households and firms are mutually interdependent

Question 2

marginal propensity to save

Answer 2

fraction of an additional dollar of disposable income that is saved

Question 3

marginal propensity to consume

Answer 3

fraction of an additional dollar of disposable income that is spent on consumption

Question 4

total increase in real GDP from $x increase in aggregate spending =

Answer 4

Question 5

with original increase in real GDP being $x, increasing spending in multiple rounds equation?

Answer 5

Question 6

equation for the change in real GDP and autonomous change in aggregate spending (AAS)

Answer 6

Question 7

equation for the multiplier

Answer 7

Question 8

the larger the MPS, the…

Answer 8

smaller the multiplier

Question 9

current disposable income

Answer 9

income after taxes are paid and government transfers are received

Question 10

consumption function

Answer 10

equation showing how an individual household’s consumer spending varies with household’s disposable income

c = a + (MPCxY_d)

c = household’s consumer spending

Y_d = household’s disposable income

a = constant; autonomous consumer spending

Question 11

autonomous consumer spending

Answer 11

what a household would spend even with 0 income

Question 12

consumption function graph

Answer 12

Question 13

aggregate consumption function

Answer 13

• relationship for the economy as a whole between aggregate disposable income and aggregate consumer spending
• C = A + (MPC x Y_D)
• same variables as other function, just aggregate

Question 14

what causes shifts in the consumption function?

Answer 14

• Shift upwards: increase in real (aggregate) wealth, increase in real (aggregate) wealth, increase in consumer confidence
• Shift downwards: decrease in these variables

Question 15

planned investment spending

Answer 15

investment spending that businesses intend to undertake in given period

Question 16

what is planned investment spending determined by?

Answer 16

• interest rates: as IRs rise, businesses stop investing because fewer projects with higher rate of return
• expected real GDP: if firms expect sales to increase, they will invest in more capital (etc.) to keep up with demand
• current level of production capacity: if firms have more than enough production capital, storage space, etc. then won’t invest in more

Question 17

accelerator sprinciple

Answer 17

higher rate of growth in real GDP leads to higher planned/investment spending

Question 18

inventories

Answer 18

stocks of goods held to satisfy future sales

Question 19

inventory investm ent

Answer 19

value of change in total investories held in an economy in a given period

Question 20

unplanned inventory investment

Answer 20

unplanned changes in inventories occurring when actual sales are more or less than expected

Question 21

actual investment spending

Answer 21

sum of planned and unplanned inventory investment

equation: I = I_unplanned + I_planned

Question 22

assumptions in the income-expenditure model

Answer 22

changes in overall spending lead to changes in aggregate output

interest rate is fixed

taxes, government transfers and government purchases = 0

imports + exports = 0

Question 23

• AE_planned = C + I_planned
• AE_planned = planned aggregate spending = total amount of planned spending in the economy

Question 24

aggregate planned spending graph

Answer 24

Question 25

1. I_unplanned > 0
2. I_unplanned < 0

Answer 25

1. firms have overestimated sales so too much addition to inventories
2. firms have underestimated sales so will be unintended decrease in inventories

Question 26

GDP equation in terms of planned expenditure

Answer 26

GDP = AE_planned + Iunplanned

Question 27

income-expenditure equilibrium

Answer 27

• when aggregate output equal to planned aggregate spending
• intersect occurs when I_unplanned = 0

Question 28

why are changes in inventories considered leading indicator of future economic activity?

Answer 28

• when planned spending doesn’t equal output shows up in inventory changes
• if drop the assumption that APL is fixed then a decrease in APL leads to an increase in AS_planned
• leads to multiplier process that increases equilibrium expendicture and income