10 Basic Macroeconomic Relationships
How is it possible for investment spending to increase even in a period in which real interest rates rises?
Any factor that contributes to businesses having a greater expectation of rates of return on there investment will increase investment. In simpler terms, anything that the business believes is worth investing in to have a greater expectation of rates of return- the business will increase investment spending. These factors include, acquisition or maintenance or operating costs, business taxes, technological change, stock of capital goods, planned inventory changes, and expectations.
Why is investment spending unstable?
Investment rises and falls most of the time. Fluctuations in output and employment are due to demand shocks caused by the sudden increase and decrease in investment. Factors that contribute to the variability of investment include expectations, durability, irregular innovation, and profits.
How does the MPC differ from MPS?
MPC= Fraction of any change in consumption MPS= Fraction of any change in savings
Is the relationship between changes in spending and changes in real GDP in the multiplier effect a direct (+) relationship or is it an inverse (-) relationship?
The relationship between changes in spending and changes in real GDP is direct (positive). The size of MPC and multiplier are directly related.
How does the size of the multiplier relate to the size of the MPC? MPS?
The size of MPS and multiplier are inversely related. Logic behind the multiplier/MPC relationship: The smaller the fraction of any change in income saved, the greater re-spending every round, ultimately a greater multiplier.
Why does a downshift of the consumption schedule typically involve an equal upshift of the savings schedule? What is the exception to this relationship?
A downshift in the consumption schedule means an upshift in saving schedule because an increase in consumption means a decrease in savings which in turn means the same thing when there is a decrease in consumption, there will be an increase in savings. Exceptions to this would be wealth, borrowing, expectations of prices, and real interest rates.
Why will a reduction in the real interest rate increase investment spending, other things equal?
A reduction of interest rates will result in an increase in investment spending because if a high interest rate is undertaken then it will exceed the expected rate of return which will cause a decrease in the firm's profit ultimately causing a decrease in investment spending. However, if a low interest rate is undertaken or if high interest rates have been reduced, then it will not exceed the expected rate of return. The low interest rates should be undertaken which would ultimately result in a high expected rate of return, giving profit to the firm, and ultimately a raise in investment spending.
How do the MPC and APC differ?
APC (Average propensity to consume): Total income consumed - Consumption/income MPC (Marginal propensity to consume): Fraction of any change in income consumed -Change in saving/change in income
Why must the sum of the MPC and the MPS equal 1?
The sum of MPC and MPS must equal to 1 because you as a consumer are either saving or spending, so the fraction of change in consumption and the fraction of change in saving must represent the change in the entire income which is represented as 1.
In what direction will each of the following occurrences shift the investment demand curve, other things equal? a) A increase in unused production capacity occurs. b) Business taxes decline. c) The cost of acquiring equipment fall. d) Widespread pessimism arises about future business conditions and sales revenues. e) A major new technological breakthrough creates prospects for a wide range of profitable new products.
a) Shift to the right b) Shift to the right c) Shift to the right d) Shift to the left e) Shift to the right
