Chap 18 Principles of Economics
Review of the four components of spending
1. Consumption 2. Investment 3. Government purchases 4. Net exports.
Equation relating consumption and disposable income (consumption function)
C = Ca = (mpc)(Y-T)
What is autonomous consumption?
Consumption spending that is not related to the level of disposable income.
Planned spending versus Actual spending
In the Keynesian model, output is determined by planned aggregate expenditure or planning spending. Planned and actual spending can differ and the most important case is that of a firm that sells either more or less of its product than expected
The basic Keynesian model key assumption
In the short run, firms meet the demand for their products at preset prices.
PAE equation
PAE = C + Ip + G + NX
What is marginal propensity to consume (mpc)?
The amount by which consumption rises when disposable income rises by $1. we assume that 0 < mpc< 1.
More details about the consumption function?
The consumption function relates consumption spending (C) to disposable income (Y - T). The vertical intercept of the consumption function is autonomous consumption and the slope of the line equals the marginal propensity to consume (mpc).
What is a menu cost?
The costs of changing prices. Firms do not normally change their prices frequently because doing so would be costly. Menu costs will not prevent firms from changing their prices indefinitely. The decision to change prices reflects a cost benefit comparison - prices should be changed if the benefit of doing so outweighs the cost.
How do changes in interest rates affect autonomous consumption?
The higher the interest rate, the more expensive it is to buy durable goods and consumption goes down. Decrease in interest rates will lower borrowing costs and the opportunity cost of saving.
What is the wealth effect?
The tendency of changes in asset prices to affect households wealth and thus their consumption spending.
What is Planned Aggregate Expenditure (PAE) ?
Total planned spending on final goods and services.
