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Chapter 8 - Basic Macroeconomic relationships (with important formulas)

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Ryerson University
ECN 204
Thomas Barbiero

Chapter 8 – Basic Macroeconomic Relationships 8.1 The Income-Consumption & Income-Saving Relationships The consumption schedule o Reflects the direct consumption-disposable income relationship o Higher income means higher consumption The saving schedule o S = DI – C o Higher income means higher saving Non-income determinants of consumption and saving Wealth: dollar amount of all household debt minus its liabilities Wealth effect: a downward shift of the saving schedule and upward shift of the consumption schedule due to higher asset wealth Borrowing: when households borrow, they increase consumption Expectations: expectations of future prices and income effect current spending and saving Real interest rates: when real interest rates (those adjusted for inflation) fall, households tend to borrow more, consume more, and save less (and vice versa) More on consumption and saving schedules Switch to Real GDP: generally the macro models focus on Real GDP Changes along schedules: movement along the curve are caused by changed in DI or real GDP Schedule shifts: changes in wealth, borrowing, expectations, and real interest rates will shift the entire consumption schedule as well as the saving schedule (in opposite directions) Taxation: shift the consumption and saving schedule in the same direction. Taxes are paid partly at the expense of consumption and partly at the expense of saving. Thus, an increase in taxes will reduce both C and S Stability: both C and S schedules are relatively stable, unless altered by a major tax change. Both C and S schedules are influenced by long-term considerations 8.2 The interest rate-investment Expected rate of return r The real interest rate o I = nominal rate – rate of inflation o Crucial in making investment decisions 8.3 Shifts in the investment-demand curve Acquisition, maintenance, and operating costs: i.e. electricity costs decrease, investment demand curve shifts right Business taxes: after tax returns are crucial to investment decisions. If business taxes increase, curve shifts to the left. If they decrease, curve shifts to the right Technological change: new products, improvements to existing products and new machinery and production processes stimulate investment Stock of capital goods on hand: if the economy is under stocked, curve moves to the right P
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