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Chapter 21, 22

ECO102H1 Chapter Notes - Chapter 21, 22: National Income And Product Accounts, Real Interest Rate, Disposable And Discretionary Income


Department
Economics
Course Code
ECO102H1
Professor
James Pesando
Chapter
21, 22

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Chapter 21 - The Simplest Short-Run
Macro Model
Desired Aggregate Expenditure
Desired aggregate expenditure (AE) - the sum of desired or planned spending on
domestic output by households, firms, governments, and foreigners
AE = C+I+G+(X-M)
National income accounts measure actual expenditures in each of the 4 expenditure
categories. Our model of the macro economy also deals with desired expenditures in each
of the 4 categories
Autonomous expenditure - elements of expenditure that do not change systematically
with national income
oThese components do not depend on national income
Induced expenditures - any component of expenditure that is systematically related to
national income
oThese components do change in response to changes in national income
Important simplifications: there is no trade with other countries aka it is a closed
economy, there is no government aka no tax, the price level is constant
Saving - all disposable income that is not spent on consumption
There are only 2 possible uses of disposable income - consumption and saving. When the
household decides how much to put to one use, it has automatically decided how much to
put the other use
Consumption function - the relationship between desired consumption expenditure and
all the variables that determine it. In the simplest case, the relationship between desired
consumption and disposable income
The key factors influencing desired consumption are:
oDisposable income
oWealth
oInterest rates
oExpectations about the future
Holding constant other determinants of desired consumption, an increase in disposable
income is assumed to lead to an increase in desired consumption
Keynesian consumption function is the assumption upon which current level of
expenditure and saving depend on their current level of income
Average propensity to consume (APC) - desired consumption divided by the level of
disposable income
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oAPC = C/YD
Marginal propensity to consume (MPC) - the change in desired consumption divided by
the change in disposable income that brought it about
oMPC = delta C/ delta YD
The consumption function has a slope of: delta C / delta YD = MPC
The consumption functions cuts the 45 degree line at the break even level of income
At the break even level of disposable income, desired consumption = disposable income
and so desired saving = 0
Average propensity to save (APS) - the proportion of disposable income that households
want to save
oAPS = S/YD
Marginal propensity to save (MPS) - relates to the change in desired saving to the change
in disposable income
oMPS = delta S / delta YD
APC + APS = 1 and MPC + MPS = 1
Changes in disposable income lead to movements along the consumption function
Changes in the other 3 factors will lead to shifts of the consumption function
Household wealth is the value of all the accumulated assets minus accumulated debts
An increase in household wealth shifts the consumption function up at any level of
disposable income; a decrease in wealth shifts the consumption function down
Durable goods are goods that deliver benefits for several years, such as cars and
household appliances
Non-durable goods are consumption goods that deliver benefits to households for only
short periods of time, such as groceries and clothing
A fall in interest rates usually leads to an increase in desired consumption at any level of
disposable income; the consumption function shifts up. A rise in interest rates shifts the
consumption function down
Expectations about the future state of the economy often influence desired consumption.
Optimism leads to an upward shift in the consumption function; pessimism leads to a
downward shift in the consumption function
Desired consumption is assumed to be positively related to disposable income
Determinants of aggregate investment expenditure:
oThe real interest rate
oChanges in the level of sales
oBusiness confidence
The real interest rate represents the real opportunity cost of using money for investment
purposes
A rise in the real interest rate reduces the amount of desired investment expenditure
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