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aggregate expenditure
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total spending on final goods and services in an economy during a given period. it is equal to GDP using the expenditure approach
GDP = AE = C + I + G + NX
GDP = AE = C + I + G + NX
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consumption
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the portion of income not saved. there is a positive relationship between consumption and income
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income
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Y = consumption (c) + savings (s)
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marginal propensity to consume
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the fraction of additional income that is spent for consumption;
MCP = (change in consumption)/(change in income). the result tells how many cents of each additional dollar goes into consumption, while the remaining is put into savings.
MCP = (change in consumption)/(change in income). the result tells how many cents of each additional dollar goes into consumption, while the remaining is put into savings.
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marginal propensity to save
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(change in savings)/(change in income)
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MPC + MPS =
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1 (100%)
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consumption function
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shows that as income increases, consumption increases. the slope is the MPC (ΔC/ΔY). and increase in consumption due to factors other than income causes an upward shift of the line.
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other factors that increase consumption
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wealth, expectations about future prices and income, household debt, and taxes. all of these cause a shift of the consumption function curve.
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what is the relationship between income and investment?
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there is no relationship between those two factors. on a graph, this is represented by a straight line and shifts upward when investment increases, or downward when investment decreases.
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investment
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spending on physical capital, equipment, inventories, and structures, including new housing.
- expected rate of return = (annual dollar earnings expected)/(purchase price).
- an investment will be made by firms only if the expected rate of return is higher than the market interest rate
- expected rate of return = (annual dollar earnings expected)/(purchase price).
- an investment will be made by firms only if the expected rate of return is higher than the market interest rate
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factors that shift the investment schedule
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expectations about future revenues and return on investment, technological change, operating costs, and capital goods on hand
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what do net exports depend on?
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the income in other countries and exchange rate.
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what is the relationship between income and government purchases?
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they are autonomous of income level
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multiplier effect
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An effect in economics in which an increase in spending produces an increase in national income (more demand for services) and consumption greater than the initial amount spent.
multiplier = 1/(1-MPC)
multiplier = 1/(1-MPC)
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GDP change
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Δreal GDP = Δ government spending x [1/(1-MPC)].
and increase in ΔG by a certain amount causes an increase in production by ΔGDP.
and increase in ΔG by a certain amount causes an increase in production by ΔGDP.
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simple tax multiplier and change in real GDP
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simple tax multiplier: -MPC/(1-MPC)
Δ real GDP = Δ net taxes x [-MPC/(1-MPC)]
Δ real GDP = Δ net taxes x [-MPC/(1-MPC)]
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change in GDP from government transfers
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Δ real GDP = Δgovernment transfers x [MPC/(1-MPC)]
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contractionary gap
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the amount by which short-run output falls short of the economy's potential output. the equilibrium point of the SRAS is less than that of the LRAS. an increase in aggregate spending necessary to bring a depressed economy back to full employment
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expansionary gap
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the amount by which output in the short run exceeds the economy's potential output, which may cause inflation. the SRAS equilibrium point is more to the right of the LRAS.
a decrease in aggregate spending is necessary to bring the overheated economy back to full employment. y* represents where the economy wants to be (LRAS point).
a decrease in aggregate spending is necessary to bring the overheated economy back to full employment. y* represents where the economy wants to be (LRAS point).
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aggregate demand curve
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a curve that shows the output of goods and services demanded at different price levels. it shows how a country spends it money relative to what it earns
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determinants that shift the long-run aggregate demand curve
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consumption, investment, government spending, and net exports. if any of them go up, it causes a shift to the right. the y axis is price and the x axis is real GDP
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long-run aggregate supply curve
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shows the real GDP that firms will produce at varying price levels. the curve is vertical and all variables are adjustable in the long run, because the economy will gravitate toward full employment. the y axis is price, and the x axis is quantity. equilibrium occurs where aggregate demand and long run aggregate supply meet, and happens at the same point as the short-run aggregate supply.
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factors that shift the long-run aggregate supply curve
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change in the amount of available resources, the quality or labor force, and available technology. an increase in any of these results in a shift to the right.
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short-run aggregate supply curve
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shows the relationship between the aggregate price level and the quantity supplied when the input prices are sticky. the curve is upward sloping, and equilibrium occurs where aggregate demand and short run aggregate supply meet and happens at the same point as the long-run aggregate supply.
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determinants that shift the short-run aggregate supply curve
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1.) input prices
2.) productivity
3.) taxes and regulation
4.) market power of firms
5.) business expectations
6.) inflationary expectations
2.) productivity
3.) taxes and regulation
4.) market power of firms
5.) business expectations
6.) inflationary expectations
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fiscal policy
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using government spending, taxes, and transfer payments to change aggregate demand and equilibrium output and price level in the economy
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automatic stablizers
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tax revenues and transfer payments automatically adjust to economy fluctuations without action by congress (occur automatically). they increase aggregate demand during recessions and reduce aggregate demand during expansions.
- ex. increase in transfer payments during recessions
- ex. increase in transfer payments during recessions
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discretionary fiscal policy
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the deliberate manipulation of government purchases, taxation, and transfer payments to promote macroeconomic goals, such as full employment, price stability, and economic growth, which require the approval of congress
- ex. president bush's tax cuts
- ex. president bush's tax cuts
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tools of discretionary fiscal policy
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government purchases, taxes, and transfer payments
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expansionary fiscal policy
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a type of discretionary fiscal policy in which there is an increase in government purchases of goods and services, a decrease in net taxes, an increase in transfer payments, or some combination of them. its purpose is to increase aggregate demand to reach the long-term equilibrium and the potential level of output (closing a contractionary gap caused by a recession).
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contractionary fiscal policy
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fiscal policy used to decrease aggregate demand. deliberate measures to decrease government expenditures and transfer payments, increase taxes, or a combination of them. it is done to close an expansionary gap and combat inflation stemming from an overheated economy.
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what is the effect of a change in net taxes?
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change in net taxes affects real GDP demanded, but to a less extent than changes in government spending.
- a decrease in net taxes increases disposable income at each level of real GDP, increasing consumption, and an increase in them reduces disposable income and reduces consumption.
- a decrease in net taxes increases disposable income at each level of real GDP, increasing consumption, and an increase in them reduces disposable income and reduces consumption.
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supply-side fiscal policy
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policies that focus on shifting the long-run aggregate supply curve to the right, expanding the economy without increasing inflationary pressures.
its main goals are to induce growth, reduce unemployment, and stabilize prices, and require more time to work than demand-side policies (lag).
- ex. spending on infrastructure, education, and technology, reducing tax rates, expanding investment, and reducing regulations.
its main goals are to induce growth, reduce unemployment, and stabilize prices, and require more time to work than demand-side policies (lag).
- ex. spending on infrastructure, education, and technology, reducing tax rates, expanding investment, and reducing regulations.
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information lag
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the data the policymakers need are not available until at least one quarter after the fact
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recognition lag
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the time needed to identify a macroeconomic problem
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decision lag
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the time it takes Congress and the administration to decide on and pass a policy once a problem is recognized.
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implementation lag
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the time needed to execute a change in policy (planning, budgeting, and implementing the program).
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what is fiscal policy often financed by?
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deficits, because policymakers find it difficult to raise taxes or reduce spending.
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