Chapter 27

What happens to real GDP when autonomous expenditure increases

Aggregate expenditure increases and so does equilibrium expenditure and real GDP. The increase in real GDP is larger than the change in autonomous expenditure.

Define disposable income

Aggregate income minus taxes plus transfer payments

What is a two-way link between aggregate expenditure and real GDP, other things remaining the same

An increase in real GDP increases aggregate expenditure, and An increase in aggregate expenditure increases real GDP.

What causes a shift in aggregate planned expenditure and aggregate demand

Any influence on aggregate planned expenditure other than the price level.

How is marginal propensity to consume calculated

As the change in consumption expenditure divided by the change in disposable income

How is marginal propensity to save calculated

As the change in saving divided by the change in disposable income

In the long run what is the effect of a change in autonomous expenditure

In the short run stage equilibrium between the new aggregate demand curve and the original short run aggregate supply curve was met. But the labour force is now more than fully employed, shortages of labour increase the money wage rate. The higher money wage rate increases firms costs and decreases short run aggregate supply so the SAS curve shifts to the equilibrium between the long run aggregate supply and the aggregate demand curves. When the money wage rate and the price levels have increased by the same percentage, real GDP is again equal to potential GDP and the economy has returned to its original place. In the long run the multiplier is zero.

What happens when aggregate planned expenditure exceeds real GDP

Inventories decrease, effectively lowering actual investment so real GDP falls to meet planned expenditure. But firms have inventory targets based on their sales, when inventories are below target firms increase production and real GDP increases. This process continues until equilibrium expenditure is reached.

What happens when aggregate planned expenditure is less than real GDP

Inventories increase, this unplanned expenditure holds real GDP in place for a short time. But with increased inventory firms decrease production until real GDP has fallen to the expenditure equilibrium or to match planned expenditure. As long as actual expenditure exceeds planned expenditure this process continues.

What is the multiplier effect with regards to autonomous expenditure?

It is the amplified change in equilibrium expenditure.

What is another way to think about autonomous expenditure

It is the level of aggregate planned expenditure if real GDP were zero.

Define marginal propensity to import

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

Define equilibrium expenditure

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

What is the slope of the consumption function equal to

The marginal propensity to consume

What is the slope of the saving function equal to

The marginal propensity to save

What are the three things that affect the multiplier and how

The multiplier is larger, The greater the marginal propensity to consume. The smaller the marginal tax rate. The smaller the marginal propensity to import.

Because in this model each firms prices are fixed what two things can be said for the economy as a whole

The price level is fixed Aggregate demand determines real GDP

Define government expenditure multiplier

The quantitated affect of a change in government expenditure on real GDP. It is calculated as the change in real GDP that results from a change in government expenditure divided by the change in government expenditure

What is consumption function

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

What is the saving function

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

What does the magnitude of the multiplier depend on

The slope of the AE curve

What is aggregate planned expenditure

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

What is the relationship between the slope of the short run aggregate supply curve with price level and real GDP

The steeper the slope of the short run aggregate supply curve, the larger is the increase in the price level and the smaller is the multiplier affect on real GDP.

Define induced expenditure

The sum of the components of aggregate planned expenditure that vary with real GDP. Induced expenditure equals consumption expenditure minus imports.

Define autonomous expenditure

The sum of those components of aggregate planned expenditure that are not influenced by real GDP. Autonomous expenditure equals the sum of investment, government expenditure, exports, and the autonomous parts of consumption expenditure and imports.

What are the two main reasons that the aggregate demand curve slopes downwards

The wealth effect and substitution effects

What is marginal propensity to save

The fraction of a change in disposable income that is saved

What is the formula for the multiplier if there are no income taxes and no imports

1/(1 - MPC) Or 1/MPS

Define marginal propensity to consume

The fraction of a change in disposable income that is spent on consumption

What changes can a change in autonomous expenditure bring about in the short run and what does it depend on

A change in real GDP, a change in the price level or a combination of both depending on aggregate supply.

Give three examples of things that will increase autonomous expenditure

A fall in the real interest rate-increased planned investment. In the 1990s Computers increase expected profits-increased planned investment. An economic boom outside of Canada - increased exports.

What is the difference between actual aggregate expenditure and aggregate planned expenditure and why are they different?

Actual aggregate expenditure is always equal to real GDP, but aggregate planned expenditure is not always equal to real GDP. This is because firms can end up with inventories that are greater or smaller than planned. People carry out their consumptive expenditure plans, the government implements it's planned expenditure on goods and services, and net exports are as planned. Firms carry out their plans to purchase new buildings, plant, and equipment. But one component of investment is the change in firms inventories. If aggregate planned expenditure is less than real GDP, firms sell less than they planned to sell and end up with unplanned inventories. Paragraph if expenditure exceeds real GDP, firms sell more then they planned to sell and end up with inventory is being too low.

Why does real GDP increase more than an increase in autonomous expenditure

Because the initial rise in real GDP increases disposable income and this also increases consumption expenditure.

What is the most basic form of the consumption function

C = a + bYD C = consumption expenditure YD = disposable income

What is the alternative formula for the multiplier if you want to avoid calculating the slope of the AE curve

Change in real GDP/change in autonomous expenditure

What two components of aggregate planned expenditure change when income changes, and because of this what do they depend on?

Consumption expenditure and imports. They depend on real GDP.

What is induced consumption

Consumption expenditure in excess of a autonomous consumption. Consumption expenditure that is induced by an increase in disposable income

What are the for most important factors that influence consumption expenditure and saving plans

Disposable income Real interest-rate Wealth Expected future income

What is important to know about the model that we study in this chapter

Firms operate like a grocery stores. Although they respond to surpluses and shortages, on any given day their prices are fixed and the quantities they sell depend on demand, not supply.

What is dissaving?

Negative saving; a situation in which spending exceeds income. Dissaving can occur when a household is able to borrow or use up existing assets.

What is the relationship between plant consumption expenditure, plant savings and disposable income?

Planned consumption expenditure + planned saving = disposable income

With a new aggregate demand curve (As the result of investment) the price level does not remain fixed, what happens in the short run?

Short run equilibrium occurs between the new aggregate demand curve and the short run aggregate supply curve (movement). The aggregate expenditure curve shifts downward. Real GDP increases but by a smaller multiplier then if the price level birth fixed.

What is the model used in this chapter called and what is it a model of

The Keynesian model It was suggested by John Maynard Keynes as a model of persistent depression

Although the MPC and MPS always equal one what is important to remember about their respective ranges

The MPC can range between zero and infinity. The MPS can be a negative or positive value

Explain the relationship between the aggregate demand curve and the aggregate planned expenditure curve

The aggregate demand curve adjusts to reflect price level changes, as a result of movement on the aggregate demand curve there is a shift in the aggregate expenditure curve when the price level changes.

What is the AE curve

The aggregate expenditure curve

What is the difference between the aggregate expenditure curve and the aggregate demand curve

The aggregate expenditure curve is the relationship between the aggregate planned expenditure and real GDP, the aggregate demand curve is the relationship between the aggregate quantity of goods and services demanded and the price level.

At a constant price level what happens to aggregate expenditure and aggregate demand when investment increases by $100 billion

The aggregate expenditure curve shifts upward and the aggregate demand curve shifts rightward to match the aggregate expenditure curve. The multiplier determines how much the A.D. curve shifts.

What is autonomous consumption

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

Define balanced budget multiplier

The change and equilibrium expenditure and real GDP that results from equal changes in government expenditure and lump-sum taxes divided by the change in government expenditure

Define autonomous tax multiplier

The change in equilibrium expenditure and real GDP that results from a change in autonomous taxes divided by the change in autonomous taxes.