Principles of Macroeconomics Chapter 11 The Short Run Macro Model Vocabulary 1 Automatic stabilizer a feature of the economy that reduces the size of the expenditure multiplier and diminishes the impact of spending changes on real GDP 2 Marginal propensity to consume the amount by which consumption spending rises when disposable income rises by one dollar 3 Autonomous consumption spending the part of consumption spending that is independent of income also the vertical intercept of the consumption function 4 Automatic destabilizers a feature of the economy that increases the size of the expenditure multiplier and enlarges the impact of spending changes on real GDP 5 Equilibrium GDP in the short run the level of output at which output aggregate 6 Consumption function a positively sloped relationship between real consumption expenditure are equal spending and real disposable income each level of income or GDP 7 Consumption income line a line showing aggregate consumption spending at 8 Expenditure multiplier the amount by which equilibrium real GDP changes as a result of a one dollar change in autonomous consumption investment spending government purchases or net exports 9 Short run macro model a macroeconomic model that explains how changes in spending can affect real GDP in the short run 10 Aggregate expenditure the sum of spending by households business firms the government the foreigners on final goods and services produced in the United States Notes Introduction In the short run spending depends on income and income depends on spending Short macro model a macroeconomic model that explains how changes in spending can affect real GDP in the short run o Developed by John Maynard Keynes in 1930s o Total spending determines the level of production and changes in spending play the central role in explaining economic fluctuations o Focuses on real variables which are adjusted for changes in price level Consumption Spending Determinants of Consumptions Spending Disposable Income income households are free to spend or save as they wish o Disposable Income Income Tax payments Transfers received o Disposable Income Income Taxes Transfers o Disposable Income Income Net taxes o A rise in disposable income with no other change causes a rise in consumption spending Wealth o Wealth is the total value of household assets home stocks bonds bank accounts minus outstanding liabilities student loans mortgage loans credit card debt o A rise In wealth with no other change causes a rise in consumption spending The Interest Rate spending o All else equal a rise in interest rate causes a decrease in consumption Why The higher the interest rate the greater the incentive to save Expectations or pay back debt o All else equal optimism about future income causes an increase in consumption spending Inheritances you expect to receive over your lifetime and how long you live can influence your consumption spending All else equal consumption spending increases when o Disposable income rises o Wealth rises o The interest rate falls o Households become more optimistic about the future Consumption and Disposable Income When real consumption expenditure is plotted against real disposable income the resulting relationship is close to linear As real disposable income rises so does real consumption spending The Consumption Function o Consumption function a positively sloped relationship between real consumption spending and real disposable income o The vertical intercept is autonomous consumption spending and the slope of the line is the marginal propensity to consume Autonomous Consumption o Autonomous consumption spending the part of consumption spending that is independent of income also the vertical intercept of the consumption function Also tells us how much consumption spending there would be in the economy if disposable income were zero Purpose to identify the particular line that represents consumption spending at positive income levels Represents the influence on consumption spending of everything other than disposable income wealth interest rate expectations The Marginal Propensity to Consume MPC o Slope Consumption Disposable Income Consumption vertical axis Disposable income horizontal axis o The marginal propensity to consume MPC is 1 the slope of the consumption function 2 the change in consumption divided by the change in disposable income or 3 the amount by which consumption spending rises when disposable income rises by one dollar o MPC should be larger than zero when income rises consumption spending will rise but less than one the rise in consumption will be smaller than the rise in disposable income 0 MPC 1 Representing Consumption with an Equation o C a b Disposable income C consumption spending a vertical intercept autonomous consumption spending represents the amount of money an individual with spend if her disposable income equaled 0 Consumption and Income b slope MPC each level of income or GDP Consumption income line a line showing aggregate consumption spending at o To draw the consumption income line we measure real income instead of real disposable income on the horizontal axis The line has the same slope as the consumption function but a different vertical intercept equal to a MPC x T Net taxes lower the consumption income line Why Because at any level of income taxes reduce disposable income and therefore reduce consumption spending Taxes cause disposable income to drop by T at any given income level which in turn causes consumption spending to drop by MPC x T o When the government collects a fixed amount of taxes from households the line representing the relationship between consumption and income is shifted downward by the amount of tax times the marginal propensity to consume MPC The slope of this line is unaffected by taxes and is equal to the MPC Shifts in the Consumption Income Line o If income increases and net taxes remain unchanged disposable income will rise and consumption spending will rise with it o A decrease in net taxes will increase disposable income at each level of income Consumption spending will then increase at any income level shifting the entire line upward o All the other influences on consumption spending other than income shift the consumption income line as well An increase in household wealth would increase autonomous consumption and shift the consumption income line forward Increases in autonomous consumption could also occur if the interest rate decreased
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