Econ 103 Study Guide

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Aggregate Expenditure: relationship showing (at a given price level) Real GDP. * Y=C+I+G+NX
Consumption Function (C): A relationship between disposable income (income-tax) and consumption * C=a+b(Y-T)
* a-autonomous spending
* b-MPC
* Y-Aggregate expenditure
* T-net taxes (tY)

* Marginal Propensity to Consume (MPC)
* Δ consumption/Δ disposable income
* Marginal Propensity to Save (MPS)
* Δ savings/ Δ DI
* DI-MPC=Savings
* MPS+MPC=1
* Determinants and Shifts in the Consumption Function
* Net Wealth (assets-liabilities)
* If Wealth up/consumption up
* Price Level
* If PL up/consumption down
* Interest Rate
* If IR up/consumption down
* Expectations
Investment (I): new factories/equipment, inventories
* autonomous (does not depend on DI)
* Depends on interest rates.
* If interest rates are high, investment is low
Government: government purchases made with federal, state and local taxes AND transfer payments (if income is up, transfer payments are down) * Autonomous
New Exports (NX): (exports-imports), autonomous
* factors that shift net exports
* Price Levels in US/ Abroad
* If inflation is higher in US we import more – Ex. Down & Im up -NX down * Interest rates in US/Abroad
* If interest rates are higher in US- Ex Up. Im Down. NX Up. * Foreign income levels
* If foreign income levels rise- Ex up. Im Down. NX up. * Exchange rate
* If US dollar is worth more- Ex down. Im Up. NX up * Marginal Propensity to import
* Y=C+I+G+(X-M)
* M=mY
* m= import rate

Real GDP demanded:
* Found when Aggregate Expenditure (Y)=Aggregate output
* Intersection of consumption function and 45 degree line * 45 degree line is where spending = real gdp
* Income expenditure model
* Measures Real GDP on horizontal and Aggregate expenditure on vertical * If spending exceeds real GDP
* Aggregate expenditure line is above 45 degree line
* Inventory reduction- prompt firms to produce more * Increases employment and consumer income
* Leads to more spending
* The increase in spending increases real gdp by more than the increase because the new intersection is much further up on 45degree line. * The increase in GDP can be found using the simple spending multiplier * If GDP exceeds Spending

* Aggregate expenditure line is below 45 degree line
* Spending falls short, unsold goods accumulate
* Firms decrease production
* Employment and income are reduced
The Simple Spending Multiplier
* In one of the components of the Aggregate expenditure shift the line upwards, then the new equilibrium level can be found by multiplying the simple spending multiplier by the Δa.e. * 1/1-MPC=Simple spending multiplier

* EX. If spending=GDP demanded at 14, and the MPC=.8… firms decide to increase their investment by .1 the consumption function shifts up. The new equilibrium is now: * 1/.2=5 (simple spending multiplier)

* Δaggregate expenditure x 5
* .1 x 5=.5
* .5+14 (original GDP demanded/equilibrium)) = 14.5 (new equilibrium) Aggregate Demand Curve
*aggregate demand curve and aggregate expenditure line portray output from different perspectives. The expenditure line shows output at a given price level, GDP demanded is found when spending=income (real gdp). So a shift in the AE line also shifts the AD line. * At each price level there is a different GDP demanded.

* A Higher Price Level REDUCES aggregate spending and GDP Demanded * Decreases real value of money- reduces consumption * Imports rise, exports fall
* Higher interest rate reduces investments
* A Lower price INCREASES...
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