Macroeconomics - Chapter 8 - Aggregate Demand and the Powerful Consumer

consumption function

shows the relationship between total consumer expenditures and total disposable income in the economy, holding all other determinants of consumer spending constant.

transfer payments

sums of money that the government gives certain individuals as outright grants rather than as payments for services rendered to employers. Some common examples are Social Security and unemployment benefits.

personal savings rate

the ratio of consumer saving to disposable income.

marginal propensity to consume (MPC)

the ratio of the change in consumption relative to the change in disposable income that produces the change in consumption. On a graph, it appears as the slope of the consumption function.

investment spending (I)

the sum of the expenditures of business firms on new plant, equipment, software and households on new homes. Financial "investments" are not included and neither are resales of existing physical assets.

disposable income

the sum of the incomes of all individuals in the economy after all taxes have been deducted and all transfer payments have been added.

national income

the sum of the incomes that all individuals in the economy earn in the forms of wages, interest, rents, and profits. It excludes government transfer payments and is calculated before any deductions are taken for income taxes.

C + I + G + (X - IM)

C = total spending by consumers I = total investment (spending on goods and services) by businesses G = total spending by government (federal, state, and local) (Ex - Im) = net exports (exports - imports)

What are the four main components of aggregate demand? Which is the largest? Which is the smallest?

Consumption (largest), government spending, investment, net exports (smallest—actually negative in the United States)

circular flow diagram

Goods > Households > Factors Market > Firms

scatter diagram

a graph showing the relationship between two variables (such as consumer spending and disposable income). Each year is represented by a point in the diagram, and the coordinates of each year's point show the values of the two variables in that year.

money-fixed assets

an asset whose value is a fixed number of dollars.

government purchases (G)

refer to the goods (such as airplanes and paper clips) and services (such as school teaching and police protection) purchased by all levels of government.

net exports (X - IM)

the difference between exports (X) and imports (IM). It indicates the difference between what we sell to foreigners and what we buy from them.

consumer expenditure (c)

the total amount spent by consumers on newly produced goods and services (excluding purchases of new homes, which are considered investment goods).

aggregate demand

the total amount that all consumers, business firms, government agencies, and foreigners spend on final goods and services.