ECON 1113 1st Edition Exam 2 Study Guide Lectures 9 18 Lecture 9 February 16 Introduction to Consumer Spending and the Keynesian Model Who was John Maynard Keynes and what did he theorize about the economy What are the definitions of each kind of spending What is disposable income and some of its characteristics and effects What are examples of both financial wealth and consumer durable goods What is the Keynesian Consumption Function Keynesian C Ftn and how is it related to average propensity to consume APC and marginal propensity MPC to consume Keynes invented the concept of the Keynesian short run model during 1930s which he explained through his book The General Theory of Money Employment and Interest written in 1936 and also known as The General Theory He believed that the overall success of economic activity was determined by how much people plan on spending This concept was formalized as Planned Total Expenditure or PTE in which PTE equaled the sum of consumer spending C investment spending I government spending G and the difference between export spending X and import spending M PTE C I G X M C spending on consumer goods and services I spending on capital goods and services G government units spending on goods and services X foreign spending on domestic goods and services M spending on foreign goods and services Disposable or after tax income Yd is total income y subtracted by taxes T Consumer expectations can be effected by future consumer goods prices and or future disposable income levels Yd is a flow variable measured over some time period as opposed to a stock variable measured at a point in time such as wealth value of assets value of liabilities wealth Financial Wealth stocks bonds savings accounts Consumer Durable Goods cars refrigerators washing machines furniture The Keynesian C Ftn is a focus on the relationship between C and Yd ceteris paribus The APC is the fraction or percentage of disposable income spent on consumer goods or APC C Yd As Yd increases APC decreases because those with a larger income are not forced to spend as much of it on consumer goods The percent of income not consume is assumed to be saved MPC is the change in C brought on by a change in Yd or MPC C Y d MPC must be a value between 0 and 1 or a positive fraction due to a fundamental law that states that people consume only a part of any increase in their Yd Lecture 10 February 18 Discussion of the Keynesian Consumption Function What does the Keynesian C Ftn look like graphically and why How is the C Ftn written mathematically and what do the different variables represent What causes shifts in the graph How did the graph shift during the stock market crash of 1987 compared to the Great Depression of the 1930s The C Ftn describes consumer spending in the economy through the MPC and APC The x axis is disposable income and the y axis is consumer spending The MPC is the slope of the C Ftn rise run in which it is depicted by C Y d The rise vertical movement of the line is delta C and the run or horizontal movement of the line is Yd that together calculate MPC This line begins above the origin on the y axis and crosses the 45 degree reference line which begins at the origin The APC is shown by the slope of this reference line from the origin to the point of interest on the C Ftn Break even income on this graph is signified when C Yd or APC 1 At this point the C Ftn crosses the reference line All incomes before this break even point show dissavings increasing and all incomes after it show savings increasing a B Yd C consumer spending Yd disposable income a autonomous consumption C that does not depend on Yd that equals the vertical intercept of the C Ftn b slope term that equals the slope of the C Ftn If credit conditions ease interest rates decrease or consumers expect higher future incomes and or higher future consumer prices the C Ftn will shift upward for all Yd In October of 1987 stock prices fell sharply closing down the stock exchange People feared that lower stock prices would imply lower consumer financial wealth which would shift the CFtn down further as C is the biggest portion of PTE If PTE decreases and overall economic activity will decrease causing a recession In this instance no recession ever occurred because policy makers lowered interest rates so although the C Ftn lowered initially it returned to normal under the policies In 1929 the government did not lower interest rates so the C Ftn remained low Lecture 11 February 25 Introduction to the Keynesian Cross Model What is inflation What is the Keynesian Cross Model and what does it look like graphically What is the inventory adjustment mechanism How does disequilibrium in nominal GDP Y alter the economy What is Y and what are possibilities that may differ from this What is a GDP gap What is the multiple concept and how does it function Inflation is the increase in the cost of money and its effects PTE reflects the entire economy through the equation C I G X M This diagram appears much like the Keynesian C Ftn however the axes and lines represent different entities The yaxis is PTE in which only the C aspect of the PTE equation changes while all other parts remain constant The x axis is Y nominal GDP is monetary units The Keynesian Aggregate Supply Line ASk is a 45 degree reference line beginning at the origin of the graph and moving outward It is a form of the supply curve within this diagram and represents the amount of goods and services suppliers are willing to produce The PTE line is calculated by the PTE equation which begins above the origin on the y axis and cross the ASk at one point This line is a form of the demand curve and represents the amount of goods and services buyers are willing to consume Inventory Adjustment Mechanism is the movement of disequilibrium in the market balancing itself and reaching the equilibrium level of nominal GDP in this instance It is the basic equilibrating force in the Keynesian Cross Model If Y is below equilibrium a shortage will occur If Y is above equilibrium a surplus will occur Y is the national target for nominal GDP and implies non inflationary full employment level of GDP However the actual Y can be above or below this level If Y is less than Y unemployment emerges thus PTE must be increased This is done through increasing the determinants as components of PTE which involves fiscal policies To raise the PTE government spending G must increase and or taxes T must decrease so that