ECON 2030; CH. 12: Aggregate Expenditure and Output in the Short Run

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

$500 million; The multiplier is 1 / (1 - MPC) so in this case it is 1 / (1 - 0.8) = 5. So a $100 million x 5 = $500 million increase in GDP.

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; An MPC of 0.9 means we spend about 90 cents of every dollar in disposable income. So, if the MPC is 0.9 and disposable income changes by $100 billion we will spend 90% of that or $90 billion; The MPS will be 0.1 since the MPC + MPS must equal 1.

What happens when there is an unplanned decrease in inventories?

Actual investment is less than planned investment; When aggregate expenditure is less than the GDP businesses will increase inventory levels. When AE is greater than the GDP businesses will sell out of inventory to make up the shortfall. Therefore, an unplanned decrease in inventory tells us that actual investment was lower than planned investment.

At points above the 45 degree line in the AE model ___?

Aggregate expenditure is greater than GDP.

Autonomous expenditures? Autonomous consumption?(definition)

Autonomous consumption and investment, which is the part of aggregate expenditures that is independent of income; The part of consumption that is independent of income.

We will all spend some minimum level for food and other necessities regardless of income level. This spending represents ______?

Autonomous consumption.

Which of these statements about autonomous expenditure is correct?

Autonomous expenditure does not depend on the level of GDP.

Which of these statements about autonomous expenditure is correct?

Autonomous expenditure does not depend on the level of GDP; By definition, autonomous expenditure does not depend on income (GDP). It is the level of spending that will occur regardless of the level of GDP.

The shift of the function in this graph could have been caused by a __________?

Change in the MPC. The slope of the line depends on consumers' marginal propensity to consume. If MPC increases, the slope will increase. If MPC decreases, the slope will decrease as shown in the graph. In this graph, it appears that consumers are saving more money.

A larger MPC means ___?

Consumers are spending more of each dollar of disposable income which results in a larger multiplier. Mathematically the multiplier is = 1 / (1 - MPC). So, an MPC of .8 will give you a multiplier of 5, while an MPC of .5 will only give you a multiplier of 2.

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

Consumption spending plus planned investment spending plus government purchases plus net exports; Aggregate expenditures cover all spending in the economy by households, government, businesses, and the net effect of imports and exports. Consumption spending is household spending on durable goods plus household spending on nondurable goods; AE = C + I + G + (X - M)--This formula is an easy way to remember the AE components.

The most important determinant of consumption is __________?

Current disposable income; In general, the higher your disposable income the more money you spend; This should be intuitive. We all tend to spend more money if we have current income that can be used for consumption.

Why can the unemployment rate never be zero (0)?

Due to frictional unemployment due to job switching.

Net exports are computed how?

Exports minus imports.

When aggregate expenditures exceed production the inventory levels will ___?

Fall and signal to firms to increase production.

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

Fall; increase.

Government corruption does impact the multiplier. T/F?

False. DOES NOT impact.

If the MPS is larger that means the MPC is larger as well since they both sum to one. T/F?

False; MPC is smaller if MPS is larger.

When aggregate expenditure is greater than GDP, the amount of total spending in the economy is _____ than production? The only way firms can sell more than what is produced is to _____ of inventories. So, inventories will fall and production and employment will go up as firms begin the process of _______ inventories.

Greater; sell out; replenishing.

An decrease in tax rates should shift the C + I + G line _____ since consumers have more money to spend? A decrease in government spending will have the ______ and shift the line down.

Higher; opposite impact.

When U.S. incomes increase faster than other countries, the U.S. will _____? The net impact will be a _____ in U.S. net exports?

Import more foreign products and do so at a faster rate than U.S. exports increase; decline.

An increase in household wealth will?

Increase the consumption component of aggregate expenditure.

An increase in household wealth will ___?

Increase the consumption component of aggregate expenditure. (E.g. If your stock portfolio doubles in value, you are more likely to take a vacation or buy a car. One study found that for every $1 your wealth increases you will spend about 5 cents of that dollar.)

An increase in __________ will cause savings to increase?

Interest Rates; For every dollar you earn, you will either use it for consumption or savings. If consumption increases, savings will fall and vice versa.

_____ will signal whether output needs to increase or decrease when the economy is not in equilibrium?

Inventories.

Investment is _____ component of GDP.

Just one.

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

MPC is larger.

As wealth increases, we are more likely to consume ___?

More and as wealth falls we tend to consume less.

What happens when incomes rise faster in the United States than in other countries? (an affect)

Net exports will fall. Typically net exports are a negative number for the U.S., so it will become a larger negative number.

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

One (1); If you spend more than you make, you will dissave (borrow) and the MPS will be negative.

The interest rate can be viewed as an ________. Higher interest rates ________ the opportunity cost of consumption.

Opportunity cost of consumption; increase.

In this graph of the income-expenditure model, what happens at y*?

Output equals planned expenditures; At the point of intersection with the 45 degree line, C + I is exactly equal to planned expenditures. Inventories are not changing at this point since spending equals output.

At points below the (45 degree) line? At points above the line?

Output is greater than expenditure; Expenditure is greater than output.

Which point on this graph best represents (C[subscript]a + I)?

Point 4. This represents the value of autonomous expenditures; Point 1 is the equilibrium level of output given this level of autonomous expenditures; Point 3 represents the level of autonomous consumption.

Higher unemployment rates _______ income which ______ consumption and saving?

Reduce; reduces.

When aggregate expenditures are less than the GDP inventories will _____?

Rise; The GDP measures production and the AE measures total spending. Therefore, when total spending is less than production you will see inventories build up; This unplanned inventory buildup will signal firms to decrease production.

The AE model only focuses on the ______ and assumes the price level is _____.

Short-run; constant.

Current disposable income? (definition)

Since most spending is financed through the income rather than savings, the most important determinant of consumption is the money you have available to spend out of your current income.

The substitution effect refers to ___?

The consumer response to a price change in one good on the number of units consumed of another good.

What does the marginal propensity to consume (MPC) represent? marginal propensity to save? (MPS)

The fraction of the next dollar in disposable income that is spent on consumption; The fraction of the next dollar that is saved. Therefore the sum of the two fractions must equal one.

Which graph best depicts the impact of an increase in exports?

The graph on the left; An increase in exports will increase X and shift the C + I + X curve upward.

(The graph on the right) Depicts a decrease in MPC that causes ____?

The line to pivot downward.

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

The marginal propensity to consume; Also represents the slope of the consumption function and it tells us how much of each new dollar in disposable income will be spent and how much will be saved.

The process that occurs when an increase in autonomous consumption leads to a bigger increase in real GDP is known as ___?

The multiplier effect; The multiplier effect also works in reverse and can lead to a larger decline in real GDP.

When the interest rate is high?

The reward for saving is increased providing households with additional incentive to save.

Household wealth is ___?

The value of a household's assets minus its liabilities (debts).

Actual investment will equal planned investment only when __________?

There is no unplanned change in inventory.

(According to the aggregate expenditure model) The economy is in short-run equilibrium when ______ = _______?

Total spending equals real GDP.

Macroeconomic equilibrium occurs where?

Total spending, or aggregate expenditure, equals total production or GDP.

Macroeconomic equilibrium occurs where ___?

Total spending, or aggregate expenditure, equals total production or GDP; Just as is the case in any market, equilibrium occurs where the supply is equal to demand, or in this case spending is equal to income (GDP).

Both household wealth and interest rates also impact consumption but not as much as current disposable income. T/F?

True.

Household wealth does not impact government purchases or business investment. T/F?

True.

The MPC + MPS = 1, so if MPC goes down, then MPS must go up. T/F?

True.

The MPC is important since it determines the spending multiplier. T/F?

True.

The basic premise of the AE model is that in any given year the level of real GDP will be determined primarily by the level of aggregate expenditure. T/F?

True.

There will always be a component of consumption that is independent of income. T/F?

True.

The multiplier effect occurs because ___?

When the first consumer buys goods and services, the cash payment becomes revenue to someone else who, in turn, consumes goods and services. So, a one-time increase in autonomous consumption will ultimately flow through the hands of many consumers and generate a larger change in real GDP.

The aggregate expenditure model focuses on the relationship between total spending and __________?

real GDP in the short run.

Macroeconomic equilibrium in the short run will ____?

will occur at a point on the 45 degree line. At any point on the 45 degree line GDP will be exactly equal to expenditures.