ECON 102 Chapter 21: Econ 102 - Chapter 21- The Simple Short-Run Macro Model

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Sunday, January 17, 2016
Chapter 21 - The Simple Short-Run Macro Model
21.1 Desired Aggregate Expenditure
Desired Aggregate Expenditure - The sum of desired or planned spending on domestic output
by households,firms,governments and foreigners.
AE = C + I + G + (X-IM)
= Consumption + Investment + Government + (Export-Imports)
Autonomous Versus Induced Expenditure
Autonomous Expenditure - Elements of expenditure that do not change systematically with
national income.
Induced Expenditure - Any component of expenditure that is systematically related to national
income.
Clauses on Chapter 21
-There is no trade with other countries (closed economy)
-no government/no taxes
-price level is constant
Desired Consumption Expenditure
Remember that disposable income is the amount of income households receive after deducting
what they pay in taxes and adding what they receive in transfers…
-in our simple economy Yd = Y (National income)
-Savings = Yd that is not spent.
Only 2 ways to use disposable income - Save or Consumption
The Consumption Function
The relationship between desired consumption expenditure and all the variables that determine
it. In the simplest case, the relationship between desired consumption expenditure and
disposable income
Factors that influence Consumption
-disposable income
-wealth
-interest rates
-future expectations
Holding constant other determinants of desired consumption, an increase in disposable
income is assumed to lead an increase in desired consumption.
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Sunday, January 17, 2016
Both desired consumption and desired saving are assumed to rise as disposable income
rises.
Average Propensity to Consume (APC) - desired consumption divided by the level of disposable
income.
APC = C/Yd
Marginal Propensity to Consume (MPC) - the change in desired consumption divided by the
change in disposable income that brought it about.
MPC = deltaC/deltaYd
THIS IS THE SLOPE OF THE CONSUMPTION FUNCTION
The 45º Line is what is called break-even level of income. (Yd = Consumption desired)
The Saving Function
Average Propensity to Save (APS) - Desired saving divided by the disposable income
APS = S/Yd
Marginal Propensity to Save (MPS)- the change in desired saving divided by the change in
disposable income that brought it about.
MPS = deltaS/deltaYd
APS+APC = 1 = MPC + MPS
Shifts of the Consumption Function
1) Change in household wealth - this is a change in the value of all accumulated assets minus
accumulated debts… An increase in household wealth shifts consumption function up,
decrease shifts consumption function down.
2) A Change in Interest Rates - long term or cost of borrowing… A fall of IR leads to increase in
desired consumption where as a rise in IR leads to decrease in consumption
3) A Change in Expectations - this is a change about future expectations… Expectations about
the future state of the economy often influence desired consumption. Optimism leads to
wards upward shift, pessimism leads to a downward shift.
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