Econ Final review CHAP 12 13 15 16 CHAP 1 4 Macro mainly focus on aggregate behavior as a whole Opportunity cost highest valued alternative that you would give up to do something PPC relationship between production of 2 different types goods when it shifts outward it means economy as a whole increases it will shift inward when the economy is doing bad Demand vs quantity demanded Supply vs quantity supplied Look at LRAS AD CHAP 12 Consumption Real GDP and the Multiplier 12 1 Simplifying assumptions in a Keynesian Model Real disposable income Real GDP net taxes Consumption spending on new goods and services it is a flow variable Saving the act of not consuming all of one s current income it is an action measured over time a flow Consumption saving investment are all flow variables Savings are a stock an accumulation resulting in the act of saving in the past Accounting identity C Consumption S Saving DI Disposable Income Consumption goods goods bought to use up food movies Investment or fixed investment businesses spend on things for the future Inventory investment changes in business inventories 12 2 Determinants of Planned Consumption and Planned saving in the classical model supply of saving was determined by rate of interest the higher the rate the more people wanted to save and the less they wanted to consume Keynes said that interest rate did not matter families will save based on what their disposable income is The life cycle theory of consumption says that when one anticipates a higher income in the future they will consume more and save less The permanent income hypothesis looks at average income over the long run Consumption function relationship between how much is consumed and disposable income shows a positive relationship between disposable income and planned consumption along the 45 degree line expenditures DI When consumption 0 that is the break even point Break even point for consumption when saving 0 also every point on the 45 degree line Dissaving when spending exceeds income Econ Final review CHAP 12 13 15 16 Autonomous consumption is independent from DI When planned consumption Real DI then saving 0 Average Propensity to consume APC Real consumption Real disposable income Average propensity to Save APS Real saving Real disposable income Marginal Propensity to consume MPC Change in real consumption change DI Marginal Propensity to save MPS change in real saving change in real DI APC APS 1 MPC MPS 1 12 3 Determinants of investment Investment consists of expenditures on new buildings and equipment As the rate of interest goes up the planned real investment per year goes down An expectation of higher future gains increases level of investment Purchases of corporate stock is not included in the flow of investment spending The planned investment function shows a negative or inverse relationship between interest rate and planned investment The most variable over time is real investment spending Decrease in taxes increase in planned investment demand 12 4 Determining Equilibrium Real GDP we want to determine the equilibrium level of real GDP per year Consumption as a function of real GDP If a firms unplanned inventories are increasing then consumers are saving more than business anticipated Equilibrium GDP is determined by the intersection of planned saving and planned investment schedules Only at equilibrium GDP will planned saving actual saving Planned investment actual investment Planned saving planned investment Investment is autonomous with respect to GDP LOOK AT MORE AD C investment I G X 12 5 Keynesian equilibrium Government G C I G Lump sum tax doesn t depend on income of taxpayer Government purchases are determined by political process The foreign sector X Net exports imports When C I G X Y we have equilibrium GDP Y unplanned decrease in inventories businesses raise output Y unplanned increase in inventories businesses reduce output Econ Final review CHAP 12 13 15 16 12 6 the multiplier 1 MPS is the multiplier remember MPS 1 MPC so the larger the MPC the larger the multiplier and the larger the MPS the smaller the multiplier The multiplier effect tends to magnify small changes in spending into larger changes in real GDP Change in equilibrium real GDP multiplier Change in autonomous spending The multiplier helps explain why a rise in government expenditures causes real GDP to rise by more than the amount of the increase in government spending 12 7 change in autonomous spending affects real GDP If ag Supply curve is upward sloping then an increase in autonomous consumption leads to an increase in aggregate demand and a rise in price level 12 8 relationship between aggregate demand and C I G X Curve consumption investment government foreign sector AD curve has price level changing the C I G X curve does not Higher price level causes the C I G X Curve to shift down A rise in price level causes a reduction in total planned real expenditures CHAP 13 Fiscal Policy 13 1 discretionary fiscal policy When the government diliberatly alters its level of spending and or taxes in order to receive national economic goals it is exercising discretionary fiscal policy An increase in government spending will stimulate economic activity shift the AD right Example of fiscal policy is reduction in lump sum taxes Changes in government spending military spending education spending budgets for agencies Change in taxes a rise in taxes causes a reduction in aggregate demand because it can reduce everything else Decrease in taxes will cause increase in demand Tax and spend policy fiscal policy Has to do only with tax level changes and government spending changes If there is inflationary gap increase taxes Recessionary gap decrease taxes Full employment when LRAS vertical SRAS 13 2 Possible offsets to fiscal policy Econ Final review CHAP 12 13 15 16 crowding out effect expansionary fiscal policy increased govnt spending causing a decrease in planned investment this decrease results from the rise of interest rates ricardian theorem saying the an increase in government budget deficit has no effect on aggregate demand because people realize there is future tax Laffer curve relationship between tax rates and revenues permanent income hypothesis individuals current consumption depends on anticipated life income direct exposure offsets actions by private sectors that would offset fiscal policy actions ex With the private hospitals not being able to expand bc of public ones or government giving