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Economics Chapter 21 Summary.docx

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Economics (Arts)
ECON 209
Mayssun El- Attar Vilalta

Chapter 21 21.1 Desired Aggregate Expenditure - Desired expenditure refers to what people would like to buy with the resources they have, not under imaginary unlimited resources - Instead of subscripting an “a” to represent desired expenditure, there is no letter so C, G, I, G and (X- IM) - We look at 4 main decision makers: domestic households, firms, gov’t and foreign purchasers - Desire aggregate expenditure or AE= C + I + G + (X- IM) - National income accounts measures actual expenditures in each of four expenditure categories. National income theory deals with desired expenditure in these 4 categories Autonomous versus Induced Expenditure - Autonomous expenditure: elements of expenditure that don’t change systematically w/ national income. They change but not b/c of national income - Induced expenditure: elements of expenditure that is systematically related to national income Important simplifications - We’re only focusing on consumption and investment in this chapter - Consumption is largest component of AE and provides most important link between desired aggregate expenditure and real national income - Investment: accumulation of inventories plus expenditure on new capital, small than consumption but more volatile (important for understanding fluctuations in GDP) - Closed economy: no foreign trade in goods, services or assets Desired Consumption Expenditure - Saving: all disposable income not spent on consumption - Only two possible uses of disposable income—consumption and saving. When deciding on how to put to use one, it has automatically decided how much to put to the other use - Distance between real per capita disposable income and real per capita consumption is real per capita savings; consumption is a function of income and they are positively related so they move together The Consumption Function - Consumption function: relationship between desired consumption expenditure and all variables that determine it; for ex: relationship between desired consumption expenditure and disposable income - Key factors influencing desired consumption: disposable income, wealth, interest rates and expectations about the future - Holding constant all other determinants of desired consumption, an increase in disposable income is assumed to lead to an increase in desired consumption - Consumption that occurs when there is zero disposable income is autonomous consumption b/c it doesn’t rely on level of income—people have to eat, survive, live somewhere (even if they can’t afford it)—y- intercept - The disposable income slope is induced consumption b/c it’s brought about by change in income The theory of the Consumption Function - Imagine 2 households: 1 short-sighted (spending everything earned) and other forward looking (put money aside for everything) - Consumption smoothing—having little fluctuations in consumption even with changes in income - Keynesian Consumption Function: any function based on the assumption that the household’s current level of expenditure and saving depended on their current level of income Average and Marginal Propensities to Consume - Average Propensity to Consume (APC)—desired consumption expenditure divided by disposable income: APC= C/ Y —conDumption per dollar of disposable income - Marginal Propensity to Consume (MPC)—relates change in desired consumption to change in disposable income. MPC = change in C/ change in Y D The slope of the Consumption Function - The slope of the consumption function is change in C/ change in disposable income therefore it is the MPC - Positive slope means MPC is positive, increases in income= increase in desired consumption - Constant slope means MPC is same at any level of disposable income (horizontal line) The 45 degree line - A line connecting where desired consumption equals disposable income—slope of 1 if both axes are given in same units - It is a reference line - Where consumption function cuts 45 degree line is “break even” level of income; disposable income= desired consumption so savings are zero - If consumption function > 45 degree line, desired consumption exceeds disposable income— desired savings is neg. b/c households are spending out accumulating savings/borrowing funds - If consumption function < 45 degree line, desired consumption is less than disposable income so savings are positive, households are paying debt or accumulating assets The Saving Function - Deciding on consuming decides automatically on savings, once we know relationship btwn consumption & income we’ll know relationship btwn desired saving & disposable income - Average Propensity to Save (APS)—S/ Y D - Marginal Propensity to Save (MPS)—change in S/ change in Y D - Relationship between saving and consumption propensities: APC + APS= 1, and MPC + MPS=1 - Regarding avg.: for every fraction of income consumed and saved must account for all income - Regarding marginal: for every increment to income consumed and save must account for all of that increment of income Shifts of the Consumption Function: - Changes in the disposable income lead to movements along the consumption function - Changes in wealth, interest rates/households’ expectations cause shifts of consumption function A change in the Household wealth: - Household wealth: all accumulated assets minus accumulated debts - Household assets: savings accounts, mutual funds, RRSPs and ownership of homes and cars - Household debts: home mortgages, car loans and outstanding lines of credit from banks - More wealth= consumption function SHIFTS up, savings function shifts down - Less wealth= consumption function shifts down, savings function shifts up A Change in Interest Rates: - Durable goods: goods that deliver benefits for several years like cars and household appliances - Non-Durable goods: consumption goods delivering short term benefits: groceries, clothes - Decrease in interest rate shifts consumption function up - Increase in interest rate shifts consumption function down A Change in Expectations - Fear of future being bad will lead households to save more thus shifting consumption down - Usually causes a self-fulfilling prophecy where rough economic time follow b/c of increased savings and reduced spending - Favourable predictions of the future will lead households to spend more, shifting consumption up Desired Investment Expenditure
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