Macroeconomics Chapter 30-31 Test
inflation rate
% change in price level; the higher the inflation rate the higher the price level
if the expenditure multiplier equals 4, then a $0.25 trillion increase in investment increases real GDP by how much?
4 = x / 0.25 x = $1 trillion
if the expenditure multiplier equals 5 and there is a $3 million increase in investment, what happens to equilibrium expenditure?
5 = x / 3 x = 15 equilibrium expenditure increases by $15 million
real GDP at full employement
= potential GDP and unemployment rate = natural unemployment rate
how does the real wage rate affect the AS curve?
along the curve the rate is fixed so an increase in price level causes a decrease in real wage rate which increases the quantity of labor employed and increases quantity of real GDP supplied
when disposable income increases from $9 trillion to $10 trillion and consumption expenditure increases from $6 trillion to $6.8 trillion, what is the MPC?
MPC = change in consumption expenditure / change in disposable income = 0.8 / 1 = 0.8
change in consumption expenditure =
MPC x change in real GDP
what does a change in price level do to the aggregate expenditure curve?
a change in price level changes the buying power of money, real interest rate, and prices of imports and exports; as it increases, the curve shifts left; as it decreases the curve shifts right
how does an increase in price level affect the phillips curve?
a rise in price level increases the inflation rate which increases the labor employed and decreases unemployment; mvmnt right on the curve
expansion on phillips curve
above anchor point; inflation is high and unemployment is low
what happens when aggregate planned expenditure is exceeded by real GDP?
above equilibrium; firms want to decrease their inventory so they decrease production
what is autonomous expenditure a component of?
aggregate expenditure that DOES NOT change when real GDP changes
disposable income
aggregate income (GDP) - net taxes (aka taxes paid to the gov - transfer payment received)
what happens when expansion is triggered by an increase in autonomous expenditure?
aggregate planned expenditure is greater than real GDP; multiplier causes expansion to increase
aggregate expenditure model
aka Keynesian model, explains what determines the quantity of real GDP demanded and changes in that quantity at given price levels
expenditure multiplier
amount by which a change in any component of autonomous expenditure is magnified/multiplied to determine the change in equilibrium expenditure and real GDP it generates
why is the expenditure multiplier larger than 1?
an increase in autonomous expenditure induces further increases in aggregate expenditure
how does the expenditure multiplier work?
an increase in investment increases real GDP which increases disposable income and consumption expenditure which adds to the increase in investment; the multiplier determines the magnitude of the resulting increase in aggregate expenditure
where does equilibrium expenditure occur?
at the intersection of the aggregate expenditure curve and the 45* line
what does consumption expenditure = ?
autonomous expenditure + induced expenditure
what does the Fed have to do to lower the expected inflation rate?
conduct monetary policy that creates confidence about the future inflation rate
induced expenditure
consumption expenditure - imports
dissaving
consumption expenditure is greater than disposable income so saving is negative
the consumption function is the relationship btwn _____ and _____
consumption expenditure, disposable income
what are the components of aggregate expenditure?
consumption expenditure, investment, government expenditure, and net exports
what does an increase in price level do to expenditure?
decreases aggregate planned expenditure and equilibrium expenditure
how does a decrease in wealth or expected future income affect consumption expenditure?
decreases consumption now = increase in saving
what does a decrease in the marginal propensity to consume do to the expenditure multiplier?
decreases it
what does a stock market crash during a recession do to consumption expenditure?
decreases it
what does an increase in autonomous spending do to the expenditure multiplier?
decreases it
what does an increase in investment do to the expenditure multiplier?
decreases it
what does an increase in the marginal tax rate do to the expenditure multiplier?
decreases it but CANNOT make it negative
marginal tax rate
determines the extent of change in income taxes when real GDP changes; MTR = change in tax payments / change in real GDP
what are the factors that affect job rationing?
efficiency wages, minimum wage laws, union wages
real GDP > potential GDP
employment exceeds full employment level and unemployment rate falls below natural unemployment rate
real GDP < potential GDP
employment is less than full employment level and unemployment rate rises above natural employment rate
what does a decrease in price level do to expenditure?
increases aggregate planned expenditure and equilibrium expenditure
what happens to induced expenditure as GDP increases?
increases bc increase in consumption expenditure is greater than the increase in imports
how does an increase in wealth or expected future income affect consumption expenditure?
increases consumption now = decrease in saving
what does a decrease in the marginal propensity to import do to the expenditure multiplier?
increases it
aggregate planned expenditure
induced + autonomous
what are the components of aggregate expenditure that change when real GDP changes?
induced expenditure
expected inflation rate
inflation rate that people forecast and use to set the money wage rate and other money prices
autonomous expenditure
investment + gov expenditure + autonomous consumption expenditure; DOES NOT respond directly to changes in real GDP; increases as real GDP increases but not by the same amount
when a higher inflation rate is expected what happens to the money wage rate?
it increases
if unplanned investment occurs then where does aggregate expenditure relate to equilibrium?
it is NOT at its equilibrium level
what are the factors that affect natural unemployment?
job search, job rationing
the greater the marginal propensity to consume the _____ the expenditure multiplier
larger
how does a decrease in AD that brings movement down along the AS curve affect the phillips curve?
lowers price level and decreases real GDP bringing the same mvmnt down along the phillips curve
how do increases in imports and income taxes (marginal tax rate) affect the multiplier?
make it smaller
how does a low marginal tax rate affect the expenditure multiplier?
makes it larger
how does a high marginal tax rate affect the expenditure multiplier?
makes it smaller
if the slope of the aggregate expenditure curve is 0.5, then what does the expenditure multiplier equal?
multiplier = 1 / 1 - slope of AE curve = 1 / (1 - 0.5) = 1 / 0.5 = 2
how does mvmnt along the AS curve correlate with the phillips curve?
mvmnt along AS curve = mvmnt along phillips curve
what do changes in price level represent on the aggregate demand curve?
mvmnt along the curve
equilibrium expenditure
occurs when aggregate planned expenditure = real GDP; where production and spending plans agree
aggregate planned expenditure
planned consumption expenditure + planned investment + planned gov expenditure + (planned exports - planned imports)
what is autonomous consumption?
the amount of consumption expenditure that would take place in the short run even if there is no current income (financed by savings and loans)
what is the result when the Fed tries to conduct monetary policy to lower unemployment?
the decrease in unemployment = increase in inflation; if a higher inflation rate becomes expected, wages and prices rise causing the actual inflation rate to rise shifting the phillips curve up; eventually unemployment will return to its original state with a permanently higher inflation rate
marginal propensity to consume
the fraction of a change in disposable income spent on consumption; MPC = change in consumption expenditure / change in disposable income
marginal propensity to import
the fraction of an increase in real GDP spent on imports; MPI = change in imports / change in real GDP
how does the MPC affect the multiplier
the greater the MPC, the larger the multiplier; the smaller the MPC, the smaller the multiplier
why do the AS and phillips curve look the way they do?
the money wage rate is fixed in the short run
why does a change in inflation cause unemployment to change?
the real wage rate changes as inflation changes causing a change in the quantity of labor demanded
what does a change in the expected inflation rate do to the short run phillips curve?
the short run curve shifts to intersect the long run curve at the new expected inflation rate
what does the phillips curve demonstrate?
the trade off btwn unemployment and inflation; a higher unemployment or inflation rate brings a lower inflation or unemployment rate
if real GDP is above equilibrium expenditure, what happens to inventories?
they are above their target or desired level
if real GDP is below equilibrium expenditure, what happens to inventories?
they are below their target or desired level
if real GDP equals aggregate planned expenditure, what happens to inventories?
they are equal to their target or desired levels
why is the long run phillips curve vertical?
unemployment will always return to the natural unemployment rate in the long run but the inflation rate can still have any value
as disposable income increases, what happens to consumption?
planned consumption expenditure increases but the increase in consumption expenditure is less than the increase in disposable income
when consumption expenditure is less than disposable income, saving is _____
positive
what does equilibrium expenditure depend on?
price level
in a given period with a fixed amount of capital and given state of technology, what does real GDP depend on?
quantity of labor employed
how does an increase in AD that prints mvmnt up along the AS curve affect the phillips curve?
raises price level and increases real GDP bringing the same mvmnt along the phillips curve
what happens when recession is triggered by a decrease in autonomous expenditure l?
real GDP is greater than aggregate planned expenditure; multiplier intensifies decrease and allows recession to take hold
what does the multiplier do at the beginning of a recession?
reinforces the initial cut in autonomous expenditure and adds force to the recession
aggregate expenditure curve
relationship btwn aggregate planned expenditure and real GDP when all other influences on expenditure plans are the same; mvmnt along the curve occurs bc of changes in real GDP
consumption function
relationship btwn consumption expenditure and disposable income other things remaining the same
long run phillips curve
relationship btwn inflation and unemployment when the economy is at full employment
aggregate demand curve
relationship btwn the quantity of real GDP demanded and price level when all other influences on expenditure plans remain the same; mvmnt along the curve occurs bc of changes in price level
what happens to the inflation rate during expansion?
rises above trend
what happens to the long and short run phillips curves when the natural unemployment rate decreases?
shift left
what happens to the long and short run phillips curves when the natural unemployment rate increases?
shift right
short run phillips curve
shows the relationship btwn the inflation rate and unemployment rate when natural unemployment rate and inflation rate remain constant
what does the marginal propensity to consume represent?
slope of the consumption function
how does the Fed fix the permanently high inflation rate once it has taken hold?
slows money growth rate and raises interest rates to slow the growth rate of AD; induces a recession until equilibrium is reached again at a lower inflation rate
the smaller the marginal propensity to consume the _____ the expenditure multiplier
smaller
what is the effect of a larger marginal tax rate?
smaller change in disposable income and real GDP after a change in autonomous expenditure (smaller multiplier)
what does the Fed do to lower unemployment?
speeds up AD growth by increasing the money growth rate and lowering interest rates
expenditure multiplier using MPC
1 / (1 - MPC) x change in investment
what is the amount of induced consumption if disposable income = $150 and autonomous consumption = $50?
150 - 50 = $100
what are the factors that affect job search?
changes in demographic, unemployment compensation, and structural change
recession on phillips curve
below anchor point; inflation is low and unemployment is high
what happens when aggregate planned expenditure exceeds real GDP?
below equilibrium; firms want to increase inventory so increase production
change in real GDP =
change in consumption expenditure + change in investment
influences on consumption expenditure
change in disposable income, change in real interest rate, wealth and expected future income
expenditure multiplier formula
change in equilibrium expenditure / change in autonomous expenditure = change in real GDP / change in investment
if the marginal propensity to consume is 0.8, what is the expenditure multiplier?
change in real GDP / change in investment = 1 / 1 - MPC = 1 / (1 - 0.8) = 1 / 0.2 = 5
the expenditure multiplier is equal to the change in _____ divided by the change in _____
equilibrium expenditure, autonomous expenditure
why does the unemployment rate return to natural unemployment in the long run?
eventually the money wage rate changes to catch up with the change in price level brought about by inflation
what happens to the inflation rate during recessions?
falls below trend
aggregate expenditure model
firms change production when sales and inventories change but DON'T change prices
what is the difference btwn aggregate expenditure and aggregate planned expenditure?
firms' change in inventory bc of consumption is unplanned; this is counted in aggregate expenditure but NOT aggregate planned expenditure
equilibrium expenditure is the level of expenditure at which _____
firms' inventories are at their desired levels
okun's law
for each % point that the unemployment rate is above or below the natural unemployment rate, real GDP is 2% below or above potential GDP
what does inflation do to the real wage rate?
forces it to increase to keep the market for labor in equilibrium; bc of inflation a constant money wage rate = a falling real wage rate
rational expectation
forecast of the inflation rate based on the Fed's forecasted monetary policy (dominant factor) along with the forecasts of other forces that influence AD and AS
how are disposable income and consumption expenditure affected by changes in real GDP?
increase as it increases, decrease as it decreases
how does the real interest rate affect consumption expenditure
increase in the real interest rate = decrease in consumption = increase in saving; decrease in the real interest rate = increase in consumption = decrease in saving
if aggregate planned expenditure exceeds real GDP, what happens to inventories?
unplanned inventories decrease so firms increase production
if aggregate planned expenditure is less than real GDP, what happens to inventories?
unplanned inventories increase so firms decrease production
autonomous consumption
when consumption expenditure is greater than disposable income; the amount of consumption expenditure that would occur in the short run even if people have no current income (from savings or loans)
natural rate hypothesis
when the inflation rate changes, the unemployment rate changes TEMPORARILY and eventually returns to the natural unemployment rate
anchor point on the phillips curve
where unemployment rate = natural unemployment and inflation rate = expected inflation rate
when consumption expenditure equals disposable income, saving is _____
zero