Macroeconomics Unit 3: Chapter 10

Investment demand curve

A curve that shows the amounts of investment demanded by an economy at a series of real interest rates.

Shifts of the investment demand curve

Acquisition, maintenance, and operating costs Business taxes Technological change Stock of capital goods on hand Planned inventory changes Expectations

How large is the actual multiplier?

Actual multiplier is lower than the model assumes. Consumers buy imported products. Households pay income taxes. Inflation. Multiplier may be 0

nonincome determinants

Amount of disposable income is the main determinant. Other determinants: • Wealth. • Borrowing. • Expectations. • Real interest rates.

Paradox of Thrift

Another important consideration: The possibility that households trying to protect themselves against a recession by saving more may inadvertently worsen the recession and hurt themselves by reducing overall consumption and economic activity.

Average propensity to consume (APC)

Fraction of total income consumed

Multiplier domino effect

Humorous example of the multiplier. One person in town decides not to buy a product. Creates a ripple effect of people not spending, following the first decision. Ultimately, the entire town experiences an economic downturn

Multiplier and Marginal Propensities

Multiplier and MPC directly related: Large MPC results in larger increases in spending. Multiplier and MPS inversely related: Large MPS results in smaller increases in spending multiplier = 1/1-MPC multiplier = 1/MPS

consumption schedule

Planned household spending (in our model)

The Multiplier Effect

Positive relationship between changes in spending and changes in real GDP. More spending = higher real GDP, lower spending means lower real GDP. Multiplier = change in real GDP/initial change in spending Change in GDP = multiplier × initial change in spending

Marginal propensity to save (MPS)

Proportion of a change in income saved. MPC + MPS = 1

other important considerations

Switching to real GDP-horizontal axis measures real GDP when focus is changed from consumption/saving and disposable income to consumption/saving and real domestic output Changes along schedules- movement from 1 point to another is a change in the amount consumed, caused solely by change in real GDP. Upward/Downward shift is caused by nonincome determinants. Simultaneous shifts- When consumption goes up, savings go down, and vise versa Taxation- change in taxation shifts consumption and saving schedules in the same direction. Stability-consumption/saving schedules are usually stable unless if there's a major tax increase/decrease

Expected rate of return

The increase in profit a firm anticipates it will obtain by purchasing capital or engaging in research and development (R&D); expressed as a percentage of the total cost of the investment (or R&D) activity. (example: a printer costs $1,000 and is only useful for a year. Suppose the next expected revenue (after paying taxes, etc.) is $1,100. Subtract 1,000 from 1,100, and the profit is 100. Divide 100 profit by 1,000 cost will give you the expected rate of return (10 percent)

Multiplier

The ratio of a change in equilibrium GDP to the change in investment or in any other component of aggregate expenditures or aggregate demand; the number by which a change in any such component must be multiplied to find the resulting change in equilibrium GDP.

Instability of investment

Variability of expectations Durability Irregularity of innovation Variability of profits

Saving schedule

• DI minus C. • Dissaving can occur.

Consumption and Saving

• Primarily determined by DI. • Direct relationship.

Average Propensity to Save (APS)

fraction of total income saved APC + APS = 1

Marginal Propensity to Consume (MPC)

proportion of a change in income consumed

The Real Interest Rate

the interest rate corrected for the effects of inflation (Example: let's use the 10% expected rate of return from the last example. Nominal interest is 15%, and inflation is 10% per year. Whoever's investing will pay back dollars with 10% less purchasing power. Nominal rate is 15%, but real rate is 5% (15-10). Compare 5% to the 10% expected rate of return: it's a good investment given the current situation.)