ECON: Intro to Aggregate Expenditures

in an economy where all spending is done by households and individuals, in equilibrium

- consumption equals disposable income. - savings equals zero.

when taxes increase

- disposable income decreases. - consumer expenditures fall.

The two variables that affect investment are the

- opportunity cost of the investment. - expected rate of return. - interest rate

The activity of investment can take a variety of forms

- the construction of a hot spring sauna - the construction of a ski loft - the purchase of real estate by households - the purchase of a new machine by a paper company - the purchase of a highway convenience store - the construction of a hot spring sauna

you can measure the size of an economy by measuring

- the total income in the economy. - how much gets spent buying all goods and services. - the value of all the final goods and services that are produced.

During the Great Depression

- wages were not falling, and high levels of unemployment persisted for years. - economics developed new ways of thinking about markets, prices, and the economy as a whole because it was perceived that classical economic theories failed to explain the Great Depression.

when stock markets crash:

1. people and firms dramatically cut back on consumption and investment. 2. real GDP falls. 3. recession can occur.

Arrange the outcomes below in the order that they occur according to the aggregate expenditures model

1. the increase in expenditures leads to increased output. 2. Increased output means higher income, some of which is spent. 3. There is a further increase in aggregate expenditures. 4. Expenditures and output rise, one after the other. 5. The economy arrives at its new equilibrium where real GDP and aggregate expenditures are both equal.

economic recession

A policy often used during an ____ is to decrease taxes.

Aggregate Expenditures Model, Expanded

AE = A + [MPC x (Y-T)] + I + G + NX

Consumption, gross investment, government purchases, and net exports

According to the aggregate expenditures model, total spending is made up of which of the following four categories?

government purchases (G)

All final goods purchased by federal, state, and local governments—such as tanks, police cars, fire engines, and office supplies—during a given time period, as well as all final services purchased from labor resources—such as airport security personnel, police officers, and teachers.

when there are taxes, the initial change in consumption will equal the:

MPC times the change in disposable income due to taxes.

reducing unemployment by increasing total expenditures.

The American Recovery and Reinvestment Act (ARRA) of 2009, which is commonly known as the "stimulus," was aimed at:

I + G + NX Schedule

The I + G + NX schedule is the sum of the investment (I), government purchases (G) and net exports (NX) schedules. The aggregate expenditures model assumes I, G, and NX don't change with real GDP so the I + G + NX schedule is horizontal.

gross investment (I)

The dollar value of all new capital purchased (as investment) and the expansion of inventories in an economy during a given time period. Gross investment is classified into three categories: business fixed investment, residential investment, and inventory investment. Sometimes referred to simply as investment.

expenditures multiplier

The effect that a $1 change in expenditure has on real GDP; calculated at the ratio of the total change in real GDP due to a change in initial expenditure.

tax multiplier

The effect that a $1 change in taxes has on real GDP; in the aggregate expenditures model, calculated as the change in output divided by an initial change in taxes.

marginal propensity to save (MPS)

The fraction of each additional dollar of income that is saved.

marginal propensity to consume (MPC)

The fraction of each additional dollar of income that is spent on consumption.

government purchases schedule

The government purchases schedule shows the relationship between government purchases (G) and real GDP (Y). The aggregate expenditures model assumes government purchases don't change with real GDP so the government purchases schedule is horizontal.

investment schedule

The investment schedule shows the relationship between investment (I) and real GDP (Y). The aggregate expenditures model assumes the interest rate doesn't change with real GDP so the investment schedule is horizontal.

full-employment real GDP

The level of real GDP produced in an economy when it is operating at the natural rate of unemployment. Also the level of real GDP when the economy is in a long-run equilibrium.

proportion of extra income that is consumed.

The marginal propensity to consume is the:

decreasing marginal benefit

The negative relationship between the marginal benefit associated with the use of a good or service and the quantity consumed. The more of a good or service that is consumed, in a given period of time, the lower the marginal benefit associated with each additional unit.

net exports schedule

The net exports schedule shows the relationship between net exports (NX) and real GDP (Y). The aggregate expenditures model assumed net exports don't change with real GDP so the net exports schedule is horizontal. Shows the level of net exports at each level of real GDP.

Ordinarily, the Congressional Budget Office (CBO) does not know exactly what the correct multiplier for each type of spending.

Therefore, it uses a high estimate and a low estimate.

The demand for labor and the level of production depend on the level of expenditure in an economy.

Which of the following statements describes the main idea behind Keynes's aggregate expenditures model?

the equilibrium condition of the aggregate expenditures model is:

Y = C + I + G + NX and AE = Y if expenditures change the model will move to a new equilibrium.

Aggregate Expenditures Model - Equilibrium

Ye = [( 1/1-MCP)] x (A+C+I+G+NX)] + [(-MPC/1-MPC) x T]

the expenditures multiplier is used to calculate

a change in real GDP whenever expenditures such as consumption, gross investment, government purchases, or net exports change.

consumption schedule

a graph showing the relationship between income and consumption.

real gross domestic product (real GDP, Y)

a measure of the constant dollar value of all final goods and services produced in a country during a fixed period of time; sometimes called inflation adjusted GDP. When an economy is in equilibrium, real GDP equals income, Y. a change in real GDP equals the expenditures multiplier times the initial change in expenditures.

aggregate expenditures model

a model, developed by John Maynard Keynes, that relates income and expenditure in an economy such that, in equilibrium, total expenditures in the economy will be equal to total output. aggregate expenditures on the vertical axis and real GDP on the horizontal axis. when the ___ is in equilibrium, expenditures real GDP (or income).

disposable income refers to

after-tax income.

the equilibrium level of real GDP is found at the intersection of the

aggregate expenditures schedule and the equilibrium line.

consumption (C)

all expenditures made by households on goods and services, like clothing, food, electronics, and recreation, during a given time period.

Critics of the Keynesian approach:

argue that increasing spending to help an economy recover is unnecessary because the economy can recover without additional government debt.

the slope of the aggregate expenditures line is the same slope of the consumption schedule.

because the only category of spending that depends on income is consumption

aggregate expenditures comprise:

consumption, investment, government spending, and net exports.

capital goods

durable (long-lasting) goods that are used to produce other goods and services. Sometimes referred to simply as capital.

low

if output is lower than the full-employment level, expenditures are too

in an economy where all spending is done by households and individuals

in equilibrium consumption equals disposable income.

uses stabilization policy

in order to keep output near its long-run or potential level, the government often

equilibrium line

in the aggregate expenditures model, the 45-degree line through the origin that represents all points at which aggregate expenditure (AE) is equal to output, or real GDP (Y).

unemployment rates reached 25%

in the early 1930's, the economic engine of the United States sputtered to a halt and unemployment rates reached a high of 25 percent in 1933.

in the absence of taxes

income and disposable income are equal. consumption schedule, crosses the equilibrium line. changing disposable income in the aggregate expenditure modal does not change the shape of the consumption schedule. the slope of the savings schedule is equal to the marginal propensity to save.

if gross investment increases;

it will shift the aggregate expenditures schedule vertically, by an amount equal to gross investment.

the multiplier effect causes the

larger change in real GDP resulting from an increase in expenditures.

a fully employed economy is one that is operating at what economists call the

natural rate of unemployment

expected rate of return

the additional profit the firm expects to earn for each dollar of physical capital purchased, expressed as a percentage. along with interest rates, does influence the investment decisions of firms. an anticipated increase in profit resulting from additional investment; expressed as a percentage of the monetary cost of the additional investment.

disposable income (DI)

the amount of income available to spend or save after taxes have been paid: calculated as income (Y) minus taxes (T), or DI = Y - T. money left over after taxes; more of this leads to more savings.

consumption is the only source of expenditures

the consumption schedule is the aggregate expenditures schedule when

recessionary gap

the difference between expenditures at the full-employment level of output and expenditures when output is less then the full-employment level.

net exports (NX)

the difference between exports (goods made domestically and purchased by foreignconsumers) and imports (goods made in other countries and purchased domestically). Net exports equals exports minus imports (NX = X - M)

output gap

the difference, or gap, between curren real GDP and full-employment real GDP.

inflationary gap

the difference, or gap, between expenditure when real GDP is above the full-employment level and the level of expenditure at full-employment real GDP. the difference between expenditures at the full-employment level of output and expenditures whe output is more than the full-employment level

Peak

the height of an economic expansion, when real GDP stops rising

optimization

the idea that people make choices in order to maximize the overall benefit, or utility, of an action subject to its cost. People will engage in an activity as long as the marginal benefit of an activity is greater than or equal to its marginal cost.

real interest rate

the interest rate paid to lenders and savers when the expected rate of inflation equals zero; the inflation-adjusted return, equal to the nominal interest rate minus the inflation rate.

autonomous consumption

the level of consumption expenditure when income is equal to zero. Autonomous consumption is funded by drawing on savings or by borrowing.

Trough

the lowest point in an economic contraction, when real GDP stops falling

investment demand

the negative relationship between the quantity of new physical and capital demanded by firms and the prevailing interest rate. shows the level of investment for each level of real interest rates

interest rate

the payment made to agents that lend or save money; expressed as an annualized percentage of the monetary amount lent or saved. Sometimes called nominal interest rate or price of money.

marginal decision making

the process of making choices in increments by evaluating the additional, or marginal, benefit against the additional, or marginal, cost of an action.

aggregate expenditures (AE)

the sum of all expenditures made in an economy on consumption, gross investment, government purchases, and net exports. In equilibrium, aggregate expenditures equals income, or real GDP.

with a small expenditures multiplier

the swings in output will tend to be smaller

the opportunity cost of of the investment occurs

when a firm makes a purchase using its own funds or borrowed funds.

economic investment

when a firm purchases capital goods to replace worn-out equipment or to expand production.

greater than the change in aggregate expenditures.

when aggregate expenditures increase, the change in equilibrium real GDP is

false

when there is no income, there can be no consumption.