CH12

AGGREGATE EXPENDITURE MODEL

focuses on the relationship between TOTAL SPENDING and REAL GDP in the short run, assuming PRICE LEVEL is constant

INVENTORY

goods that have been produced but not yet sold

CONSUMPTION SPENDING

household spending on goods and services

AGGREGATE DEMAND CURVE

illustrates the relationship between PRICE LEVEL and the QUANTITY OF PLANNED AGGREGATE EXPENDITURE, holding constant all other factors that affect aggregate expenditure

Key idea in the aggregate expenditure model

in any particular year, the level of GDP is determined mainly by the level of aggregate expenditure

A decrease in the real interest rate will:

increase consumer's purchases of durable goods

MARGINAL PROPENSITY TO SAVE

the change in saving / change in disposable income

MULTIPLIER

the ratio of the increase in equilibrium real GDP to the increase in autonomous expenditure

General formula for the Multiplier

1 / MPS

MPC + MPS =

1

An increase in aggregate expenditure has what result on equilibrium GDP?

GDP rises

An unplanned increase in inventories results in:

actual investment is greater than planned investment

If inventories decline by more than analysts predict they will decline, this implies that:

actual investment spending is less than planned investment spending

An unplanned decrease in inventories occurs when:

aggregate expenditure is greater than GDP

How does an increase in price level affect consumption spending?

an increase in price level lowers real wealth, causing consumption to decrease

Why do decreases in price level result in a rise in aggregate expenditure?

causes firms and consumers to hold less money, which lowers interest rate. Lower interest rates raise consumption and planned investment expenditures

Why do increases in price level result in a decline in aggregate expenditure?

causes firms and consumers to hold more money, which raises interest rate. Higher interest rates lower consumption and planned investment expenditures

What impact does an increase in price level in the US have on net exports and why?

decreases net exports by increasing the relative cost of American goods

CONSUMPTION FUNCTION

describes the relationship between consumption spending and disposable income

What impact does a decrease in price level in the US have on net exports and why?

increases net exports by reducing the relative cost of American goods

An increase in price level in the US will have what effect on the aggregate expenditure line?

line will shift downward

A decrease in price level in the US will have what effect on the aggregate expenditure line?

line will shift upward

Increases in the price level will:

lower consumption because real wealth decreases

When aggregate expenditure = GDP,

macroeconomic equilibrium occurs

When total spending = total production,

macroeconomic equilibrium occurs