Advanced Economics Summary

Advanced Economics

(( CHAPTER 30 ))

Disposable income: is income after taxes (DI = C + S)
- Households spend most of their income (C)
- The higher the DI, the more (a higher % of DI) people are able to save.

APC: Average propensity to consume (Rule: consumption / disposable income)
APS: Average propensity to save (Rule: savings / disposable income)
- Which part of your DI is consumed, and which part is saved?
- APC + APS = 1

Marginal propensities: the portion/part of a change (increased) disposable income
(DI) channeled into increased consumption (MPC) and increased savings (MPS)
- MPC = (change in) C / (change in) DI
- MPS = (change in) S / (change in) DI
- MPS + MPC = 1
- Decrease is also possible


• Change
in
real
GDP
à change
on
the
curve!

• Change
in
one
of
the
other
determinants à change
of
the
curve!


• micro
level
à macro
level

à effect
of
changes
in
C
and
S
on
Real
GDP
instead
of

DI



Investments:

-­‐ Spending
on
new
plants,
tools,
machinery,
capital
equipment,
inventories,

construction,
computers,
etc.

-­‐ Companies
think
they
can
make
profit
with
it
(the
expected
rate
%
of
return
‘r’
i.e.

expected
profit
/
costs)

-­‐ Companies
need
to
borrow
money
—>
this
costs
the
real
interest
rate
“i”

-­‐ Expected
rate
of
return
“r”
>
Real
interest
rate
“i”
=
Investment!

-­‐ Expected
rate
of
return
“r”
<
Real
interest
rate
“i”
=






No
Investment!



The
expected
rate
of
return
equation:
(net
revenue
-­‐
cost)
/
cost


,Changes:

-­‐ If
the
interest
rate
“r”
changes
=
movement
on
the
curve

-­‐ If
anything
else
changes
=
movement
on
the
curve

-­‐ Compare
again
with
supply
and
demand!

-­‐ Other
factors
include:
costs,
taxes,
technological
changes,
excess
production
capacity,

expectations,
planned
inventory
changes.



(more
investment/
spending
—>
HIGHER
GDP!)



The
Multiplier
Effect:
a
change
in
spending
usually
increases
GDP
more
than
the
initial

change
in
investment
spending.

-­‐ An
initial
change
in
investment
“i”
will
set
off
a
spending
chain
in
the
economy.
This

will
lead
to
a
multiple
change
in
GDP.

-­‐ MPC
&
MPS
are
of
importance
here.
Which
part
of
extra
income
will
be
consumed,
and

which
part
will
not?

-­‐ MULTIPLIER
RULE
=
Change
in
real
GDP
/
Initial
change
in
spending.


-­‐ OR:
Change
in
real
GDP
=
Multiplier
x
Initial
change
in
spending.



Multiplier
and
MPS
are
inversely
related:
Large
MPS
results
in
smaller
increases
in
spending

and
a
smaller
multiplier.

Multiplier
and
MPC
are
directly
related:
Large
MPC
results
in
larger
increases
in
spending

and
a
larger
multiplier.



How
much
will
output
increase
if
government
spending
increases
by
1
billion?
(GDP
=

Consumption
“C”
+
Investment
“I”
+
Government
spending
“IG”
+
Net
exports
“X+M”)

-­‐ Simple
Spending
Multiplier:
Shows
how
much
economic
output
increases
with
an

increase
in
spending.


-­‐ Economists
ask
how
much
did
the
real
GDP
change
when
a
component
of
aggregate

demand
changed?

-­‐ To
understand
the
simple
spending
multiplier,
you
have
to
know
how
likely
people
are

to
spend
vs
save
in
the
extra
income
they
get.
Because
this
determines
how
big
the

multiplier
effect
will
be.

-­‐ If
MPC
is
80%
that
means
that
consumers
are
likely
to
spend
80%
of
any
extra
income

they
get.
Same
goes
to
MPS.


-­‐ What
ever
the
MPC
is,
subtract
it
by
1
and
you
will
get
the
MPS.

-­‐ The
(FORMULA)
for
the
simple
spending
multiplier
is
1
(divided
by)
MPS

-­‐ To
know
the
maximum
increase
in
GDP
for
the
answer
of
the
question,
Additional

spending
(1
billion)
x
Simple
spending
multiplier
(1/0.2=5)
=
5
billion.


, -­‐ An
increase
in
government
spending
lead
to
an
increase
in
economic
output
by
5

times.

-­‐ The
economic
meaning
of
(B)
is
MPC

-­‐ The
economic
meaning
of
(1-­‐B)
is
MPS

—————————————————————————————

((
Chapter
31
))



Equilibrium
GDP:
is
the
amount
that
will
be
spent
at
each
level
of
output/GDP/disposable

income.

-­‐ combine
the
consumption
schedule
with
investment
schedule
to
get
aggregate
(total)

expenditures
(in
closed
economy)

-­‐ where
total
production/output
=
total
expenditure/spending.


-­‐ GDP=
C
+
Ig

—>
no
overproduction
excess
spending

-­‐ C
+
Ig
=
Aggregate
Expenditure




Consumption
schedule:
A
table
that
illustrates
the
level
of
consumption
that
corresponds

with
each
level
of
income.

Saving:
is
what
the
consumer
does
not
spend
(a
withdrawal
of
spending.)

Investments:
(the
purchasing
of
capital
goods)
is
an
injection
of
spending.


-­‐
If
S
is
not
equal
to
I,
then
C
+
I
is
not
equal
to
GDP.
so
no
equilibrium.

Features
at
equilibrium:
there
are
no
upland
changes
in
inventories.
Firms
do
not
need
to

change
their
production.

-­‐ all
unplanned
changes
in
inventory
only
occur
when
C
+
I
is
not
equal
to
GDP

-­‐ NO
change
in
unemployment

-­‐ and
eventually
things
go
to
equilibrium
GDP

Multiplier
and
Equilibrium
GDP:
The
multiplier
plays
an
important
role.
Just
like
the

spending
multiplier,
the
multiplier
will
magnify
an
increase
in
one
of
the
components
of

AD.

-­‐ suppose
a
change
in
investments
(depending
in
the
real
interest
rate
and
expected
rate

of
return).
An
increase
or
decrease
in
investments
will
change
the
equilibrium
GDP
by
a

“bigger”
amount.

-­‐ EX:
1/MPS;
Here
MPC
=
0.75,
MPS
=
0.25
—>
Multiplier
-­‐=
4.

A
$5
billion
increase
in

investments
leads
to
an
increase
of
$20
billion
in
equilibrium
GDP
(multiplier
is
4)
and

also
$5
billion
of
new
savings
(S=1)


-­‐ Results:
change
of
the
curve
C
+
Ig



International
Trade:


-­‐ Exports
(X)
and
Imports
(M)
or
net
exports
(X-­‐M
=
Xn)
are
added
independent
of
GDP