Chapter 8: Basic Macroeconomic Relationships

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Chapter 8: Basic Macroeconomic Relationships
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2012-04-07 15:58:52
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Basic Macroeconomic Relationships
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Chapter 8: Basic Macroeconomic Relationships
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  1. The Consumption Schedule:What is the consumption-disposable income relationship?
    higher income --- > higher consumption
  2. The Saving Schedule:What is the income-saving relationship?
    Higher income --- > Higher saving
  3. Define Saving
    • Disposable income not consumed
    • S = DI - C
    • Savings = Disposable income - consumption
  4. Define Disposable Income
    After tax income
  5. Define Break-Even Income
    Income level at which households consume all income and save none of it.
  6. Describe the Consumption/Disposable Income Schedule


    • 45 degree line - consumption = disposable income
    • "c" line - consumption
    • Distance between 45 degree and C - savings
  7. Define APC
    • Average Propensity to Consume:
    • Fraction/percentage of income that is consumed

    APC = consumption/income
  8. Define APS
    • Average Propensity to Save
    • Fraction/percentage of income that is saved

    APS = saving/income
  9. What is the relationship between APC and APS?
    APC + APS = 1
  10. Define MPC
    • Marginal Propensity to Consume
    • Fraction or percentage of the CHANGE in income that is spent

    MPC = change in consumption/change in income
  11. Define MPS
    Fraction or percentage of CHANGE in income that is saved

    MPS = change in saving/change in income
  12. What is the relationship between MPC and MPS?
    MPC + MPS = 1
  13. Non-Income Determinants of Consumption and Saving:
    1. Wealth
    • Wealth Effect:
    • Shifts consumption schedule upward and the saving schedule downward
  14. Non-Income Determinants of Consumption and Saving:
    2. Borrowing
    • Temporary higher consumption
    • Long run lower consumption
  15. Non-Income Determinants of Consumption and Saving:
    3. Expectations
    • a. Expectation of rising prices tomorrow = more spending and less saving today
    • b. Expectation of lower income in the future = less consumption and more saving today
  16. Non-Income Determinants of Consumption and Saving:
    4. Real Interest Rates
    • a. Low Interest Rates
    • Borrow more
    • Consume more
    • Save less
    • Shifts consumption schedule slightly upward
    • Shifts saving schedule slightly downward

    • b. High Interest Rates
    • Borrow less
    • Consume less
    • Save more
    • Shifts consumption schedule slightly downward
    • Shifts saving schedule slightly upward
  17. Movement from one point to another on the consumption schedule:
    Is caused by a CHANGE in DISPOSABLE INCOME
  18. A shift of the entire consumption schedule:
    • Is caused by one of the four non-income determinants of consumption and saving:
    • Wealth
    • Borrowing
    • Expectations
    • Interest Rates

    These four things shift the consumption schedule and saving schedule in opposite directions
  19. Explain Taxation
    Shifts the consumption schedule and saving schedule in the same direction
  20. Explain Real Interest Rate
    i = nominal rate - rate of inflation
  21. What relationship does the Investment Demand Curve illustrate?
    • Inverse relationship between the real interest rate and the quantity of investment demanded
  22. Explain shifts in the Investment Demand Curve
    • Increases in investment demand: rightward shifts
    • Decreases in investment demand: leftward shifts

  23. Shifts in the Investment Demand Curve
    1. Aquisition, Maintenance and Operating Costs
    • When costs fall, the expected rate of return rises, shifting the investment demand curve to the right
    • When costs rise, the curve shifts to the left
  24. Shifts in the Investment Demand Curve
    2. Business Taxes
    • An increase in business taxes lowers the profitability of the firm, shifting the investment demand curve to the left
    • A reduction of taxes shifts the curve to the right
  25. Shifts in the Investment Demand Curve
    3. Technological Change
    A rapid rate of technological progress shifts the investment demand curve to the right
  26. Shifts in the Investment Demand Curve
    4. Stock of Capital Goods on Hand
    • Excess production capacity (overstocked): curve shifts leftward
    • Understocked: investment demand curve shifts rightward
  27. Shifts in the Investment Demand Curve
    5. Planned Inventory
    • Plans to increase: curve shifts right
    • Plans to decrease: curve shifts left
  28. Shifts in the Investment Demand Curve
    6. Expectation
    • Positive expectations: Right
    • Negative expectations: Left
  29. Define The Multiplier
    The relationship between changes in GDP and changes in spending (expenditure)

    MULTIPLIER = change in GDP / Change in Spending

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