Chapter 28

autonomous expenditure

The sum of investment, government expenditure, and exports, which does not vary with real GDP; Autonomous expenditure equals the sum of investment, government expenditure, exports, and the autonomous parts of consumption expenditure and imports.

Aggregate planned expenditure

The sum of planned consumption expenditure, planned investment, planned government expenditure on goods and services, and planned exports minus planned imports.

induced expenditure

The sum of the components that vary with real GDP—consumption expenditure minus imports; induced expenditure equals consumption expenditure minus imports

Marginal Prosperity to Import (MPI)

is the fraction of an increase in real GDP that is spent on imports. It is calculated as the change in imports divided by the change in real GDP, other things remaining the same

aggregate expenditure schedule

lists aggregate planned expenditure generated at each level of real GDP

When the price level changes

a wealth effect and substitution effects change aggregate planned expenditure and change the quantity of real GDP demanded

At points above the 45 degree line in the AE model:

aggregate planned expenditure is greater than GDP.

Fluctuations in total spending in the economy may affect:

both employment and production in the short run.

45 line

consumption equals disposable income any where along the line.

Aggregate expenditure, or the total amount of spending in the economy, equals:

consumption spending plus planned investment spending plus government purchases plus net exports.

The most important determinant of consumption is __________.

current disposable income

When aggregate planned expenditure is greater than GDP, inventories will __________ and GDP and total employment will __________.

fall, increase

Marginal Prosperity to Consume (MPC)

he fraction of a change in disposable income that is spent on consumption. It is calculated as the change in consumption expenditure divided by the change in disposable income

The sum of the marginal propensity to consume (MPC) and the marginal propensity to save (MPS) equals:

one

When real GDP increases:

planned consumption expenditure and planned imports increase

The aggregate expenditure model focuses on the relationship between aggregate planned expenditure and __________.

real GDP

When aggregate planned expenditures are less than the real GDP, inventories will:

rise

When consumption expenditure exceeds disposable income:

saving is negative (dissaving)

Multiplier

the amount by which a change in autonomous expenditure is magnified or multiplied to determine the change in equilibrium expenditure and real GDP.

Equilibrium expenditure

the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP

The amount by which consumption spending increases when disposable income increases is called __________.

the marginal propensity to consume

An increase in __________ will cause savings to increase.

interest rates

aggregate expenditure curve

is a graph of the aggregate expenditure schedule

autonomous consumption

is the amount of consumption expenditure that would take place in the short run even if people had no current income

induced consumption

is the consumption expenditure that is induced by an increase in disposable income

Marginal Propensity to Save (MPS)

is the fraction of a change in disposable income that is saved. It is calculated as the change in saving (ΔS) divided by the change in disposable income (ΔYD)

If real GDP exceeds aggregate planned expenditure:

there is an unplanned increase in inventories

Actual investment will equal planned investment only when __________.

there is no unplanned change in inventory

When consumption expenditure is less than disposable income:

there is saving

If you divide both sides of ΔS + ΔC by ΔYD, you get 1.

ΔC/ΔYD + ΔS/ΔYD = 1

Savings plus consumption expenditure equals disposable income:

ΔS + ΔC = ΔYD

The change in real GDP equation

ΔY = ΔN + ΔA, where Y is real GDP, N is induced expenditure, and A is autonomous expenditure

ΔC/ΔYD is the marginal propensity to consume (MPC), and ΔS/ΔYD is the marginal propensity to save (MPS), so

MPC + MPS = 1

Marginal Prosperity to Consume (MPC) equation

MPC = ΔC/ΔYD, where ΔC is consumption expenditure and ΔYD is disposable income

The value of the multiplier is larger when the value of the __________.

MPC is larger

Marginal Propensity to Save (MPS) equation

MPS = ΔS/ΔYD, where ΔS is savings and ΔYD is disposable income

The slope of the AE curve equals the marginal propensity to consume (MPC)

Multiplier = 1 / 1 - MPC but (1 - MPC) = MPS Multiplier = 1 / MPS

Multiplier equation

Multiplier = Change in equilibrium expenditure/Change in autonomous expenditure

induced expenditure equation

N = ΔC - ΔM, where N is induced expenditure, C is consumption expenditure and M is imports

Actual aggregate expenditure is always equal to

Real GDP

Slope of AE; aggregate planned expenditure

Slope of AE curve = ΔN ÷ ΔY So, ΔN = Slope of AE curve x ΔY

consumption function

The relationship between consumption expenditure and disposable income, other things remaining the same

Saving Function

The relationship between saving and disposable income, other things remaining the same

The Size of the Multiplier

The size of the multiplier is the change in equilibrium expenditure divided by the change in autonomous expenditure.

If the MPC is 0.8, then a $100 million increase in government expenditures will increase equilibrium GDP by __________.

$500 million

If the marginal propensity to save (MPS) is 0.2, how much additional consumption will result from an increase of $100 billion in disposable income?

$80 billion

If the marginal propensity to consume (MPC) is 0.9, how much additional consumption will result from an increase of $100 billion in disposable income?

$90 billion

Two-Way Link Between Aggregate Expenditure and Real GDP Other things remaining the same:

- An increase in real GDP increases aggregate expenditure. - An increase in aggregate expenditure increases real GDP.

What happens when there is an unplanned decrease in inventories?

Actual investment is less than planned investment.

mulitplier effect

An effect in economics in which an increase in spending produces an increase in national income and consumption greater than the initial amount spent.

Which of these statements about autonomous expenditure is correct? - Autonomous expenditure does not depend on the level of GDP. - Autonomous expenditure depends on the level of GDP. - No part of consumption is autonomous.

Autonomous expenditure does not depend on the level of GDP.

Why Is the Multiplier Greater than 1?

The multiplier is greater than 1 because an increase in autonomous expenditure induces further increases in aggregate expenditure.

Business Cycle Turning Points

Turning points in the business cycle—peaks and troughs—occur when autonomous expenditure changes. - An increase in autonomous expenditure brings an unplanned decrease in inventories, which triggers an expansion. - A decrease in autonomous expenditure brings an unplanned increase in inventories, which triggers a recession.

When incomes rise faster in the United States than in other countries:

U.S. net exports will fall.

disposable income equation

YD = Y - T, where Y is real GDP and T is net taxes

An increase in household wealth will:

increase the consumption component of aggregate expenditure