Aggregate Demand and Supply Concepts
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Questions and Answers

What does Disposable Income (DI) represent?

  • Income earned from foreign investments
  • Total income before taxes and transfers
  • Income after all taxes and transfers have been deducted (correct)
  • Income solely derived from government benefits

    • Which component is NOT part of the Expenditure Method for measuring GDP?

  • Gross private domestic investment
  • Government debt (correct)
  • Net exports
  • Consumer spending

    • What does the circular flow of income illustrate?

  • The overall savings rate of households
  • The flow of foreign direct investment into the economy
  • The exchange of goods and services among economic sectors (correct)
  • The amount of taxes collected by the government

    • In the Expenditure Method formula, what does 'G' stand for?

    <p>Government purchases of goods and services</p> Signup and view all the answers

    Which of the following is considered a withdrawal in the circular flow of income?

    <p>Saving deposits by households</p> Signup and view all the answers

    What does the symbol 'C' represent in the GDP formula Y = C + I + G + (X - IM)?

    <p>Consumer spending</p> Signup and view all the answers

    Which of the following best describes injections in the circular flow of income?

    <p>Expenditures from outside the household sector</p> Signup and view all the answers

    Which method is NOT used to measure GDP?

    <p>Equipment depreciation method</p> Signup and view all the answers

    What does Aggregate Demand represent?

    <p>The total spending by all sectors on final goods and services</p> Signup and view all the answers

    Which of the following is NOT a component of Aggregate Demand?

    <p>National Income</p> Signup and view all the answers

    Investment Spending includes expenditures on which of the following?

    <p>New homes and business expenditures on plant and equipment</p> Signup and view all the answers

    What is meant by Net Exports (NX)?

    <p>The difference between total exports and imports</p> Signup and view all the answers

    How is National Income calculated?

    <p>Sum of all incomes earned by individuals excluding transfers</p> Signup and view all the answers

    Which of the following correctly describes Government Spending?

    <p>Comprises both purchases of goods and services by all levels of government</p> Signup and view all the answers

    What is the formula for calculating Aggregate Demand?

    <p>AD = C + I + G + (X - IM)</p> Signup and view all the answers

    What defines Aggregate Supply?

    <p>The total quantity of goods and services produced in the economy at various price levels</p> Signup and view all the answers

    What is the primary reason transfer payments are excluded from G in GDP calculations?

    <p>Including them would result in double counting.</p> Signup and view all the answers

    According to the income method, what is the formula used to calculate GDP?

    <p>GDP = Wages + Interest + Rentals + Profits - Purchases from other firms</p> Signup and view all the answers

    What does the Output method or Value Added Approach specifically aim to prevent?

    <p>Counting of intermediate goods in GDP</p> Signup and view all the answers

    When calculating GDP using the value added approach, which of the following components is included in the value added?

    <p>Proceeds from selling final goods minus costs of intermediate goods</p> Signup and view all the answers

    In terms of consumption, which factor is NOT considered a determinant of consumer spending?

    <p>Government tax policy</p> Signup and view all the answers

    What does the term 'net exports' refer to in the context of GDP?

    <p>Exports of goods minus imports of goods and services</p> Signup and view all the answers

    Which of the following correctly describes the value added by a firm?

    <p>Revenue from sales minus the value of intermediate goods purchased</p> Signup and view all the answers

    Which situation correctly exemplifies the exception to the rules in GDP concerning government outputs?

    <p>Government purchases of new cars for official use</p> Signup and view all the answers

    What does the marginal propensity to consume (MPC) represent?

    <p>How much more consumers will spend if disposable income rises by $1</p> Signup and view all the answers

    If the MPC is 0.85, what is the MPS?

    <p>0.15</p> Signup and view all the answers

    Which situation would cause a shift to the right in the consumption function?

    <p>Higher inflation rates</p> Signup and view all the answers

    What happens when income increases by an amount and the MPC is given?

    <p>Total consumption rises by a fraction of the income increase times the MPC</p> Signup and view all the answers

    If consumption in Jamaica is $10,000 and MPC is 0.6 with an income increase of $500, what is the new level of consumption?

    <p>$10,300</p> Signup and view all the answers

    How does a decrease in price levels generally affect the consumption function?

    <p>It allows for increased disposable income, shifting the function upward</p> Signup and view all the answers

    Which of the following accurately describes a characteristic of the consumption function?

    <p>It reflects total consumer expenditures and total disposable income while holding other factors constant</p> Signup and view all the answers

    What is the total consumption if the MPC is 0.7 and the initial consumption is $5,000 with an increase of $1,000 in income?

    <p>$5,900</p> Signup and view all the answers

    How does a higher real interest rate affect consumer purchasing power?

    <p>It decreases purchasing power, shifting the consumption function inwards.</p> Signup and view all the answers

    What effect do expectations of future income have on consumer spending?

    <p>They may induce consumers to spend more, shifting the consumption function upwards.</p> Signup and view all the answers

    How are government outputs valued in GDP calculations when market prices are not available?

    <p>At the cost of the inputs that produce them.</p> Signup and view all the answers

    What happens to goods produced but not sold in a given year concerning GDP?

    <p>They are counted as inventory, increasing GDP.</p> Signup and view all the answers

    Why are investment goods considered final products in GDP calculations?

    <p>They are used by firms to produce other goods without being sold.</p> Signup and view all the answers

    What type of activities is excluded from GDP calculations?

    <p>Illegal or black market activities.</p> Signup and view all the answers

    Which of the following statements accurately reflects the treatment of purely financial activities in GDP?

    <p>They are excluded as they do not represent production of goods or services.</p> Signup and view all the answers

    How does the consumption function shift in response to expectations of income loss?

    <p>It shifts downwards, indicating a decrease in consumer spending.</p> Signup and view all the answers

    Study Notes

    Aggregate Demand

    • Aggregate demand is the total amount spent on final goods and services by consumers, businesses, government agencies, and foreigners.
    • The actual value of aggregate demand depends on the price level, consumer income, government policies, and events in foreign countries.

    Components of Aggregate Demand

    • Consumer Expenditure (C): The total amount spent by consumers on newly produced goods and services, excluding new homes. It's the largest component of aggregate expenditure.
    • Investment Spending (I): Includes expenditures by businesses on new plant and equipment and by households on new homes. Financial investment is not included.
    • Government Spending (G): Refers to the goods (e.g., planes, paper clips) and services purchased by all levels of government.
    • Net Exports (NX): The difference between exports (X) and imports (IM), indicating the difference between goods exported and imported.

    Aggregate Supply

    • Aggregate supply is the total quantity of goods and services all businesses in a nation are willing to produce at each possible price level over a specified period, holding other determinants constant.

    National Income

    • National income (NI) is the sum of all incomes earned by individuals in the economy, including wages, interest, rents, and profits.
    • It excludes government transfer payments and is calculated before any deductions for income tax.

    Disposable Income

    • Disposable income (DI) is the sum of all incomes of individuals in the economy after taxes have been deducted and transfer payments added.
    • DI = NI - (taxes + transfers)

    Circular Flow of Income

    • A simplified model showing how income flows around the economy in exchange for goods and services between various sectors contributing to economic activity.

    Injections

    • Additions to the circular flow of income originating from outside the household sector, representing expenditures on domestic goods and services.
    • Examples include investment expenditure, government expenditure, and export revenues.

    Withdrawals

    • The portion of national income not spent by households on domestically produced goods and services.
    • Examples include savings, taxes, and spending on imports.

    Measuring GDP

    • There are three methods: expenditure, income, and output/value added.

    The Expenditure Method

    • Calculates GDP by adding the final demand for all consumers, businesses, government, and foreigners.
    • Y = C + I + G + (X - IM) where Y represents GDP.

    Components of the Expenditure Method

    • C: Represents consumer spending.
    • I: Gross private domestic investment - includes investments by both private and government sectors, with machinery sold to foreign companies counted as exports.
    • G: Government purchases - include current goods and services but exclude transfer payments.
    • NX: Net exports (exports - imports).

    The Income Method

    • Calculates GDP by adding up all the incomes in the economy, including wages, interest, rents, and profits.

    The Output (Value-Added) Method

    • Accounts for the value added by each sector of the economy to avoid double-counting.
    • Value added = Sales revenue - Purchases from other firms = Wages + Interest + Rents + Profits.

    Marginal Propensity to Consume (MPC)

    • The slope of the consumption function on a graph, representing how much more consumers will spend if disposable income rises by $1.

    Marginal Propensity to Save (MPS)

    • The fraction of an extra dollar of income that goes to extra saving.
    • MPC + MPS = 1

    Consumption Function

    • Shows the relationship between total consumer expenditures and total disposable income, holding other factors constant.

    Shift in Consumption Function

    • A movement along the consumption function is caused by a change in disposable income only.
    • A shift of the consumption function indicates a change in determinants other than disposable income.
    • A rightward shift indicates decreased consumer spending, a leftward shift indicates increased consumer spending.

    Factors Affecting Consumption

    • Consumer Wealth: Increased wealth encourages spending, shifting the function upward.
    • Price Level: Lower price levels mean more disposable income for consumers, leading to increased spending.
    • Inflation Rate: Higher inflation reduces purchasing power, shifting the function outward.
    • Real Interest Rate: Higher real interest rate on borrowing reduces purchasing power, shifting the function outward.
    • Future Income Expectations: Expectations of higher income lead to increased spending, shifting the function upward.

    Exceptions to GDP Rules

    • Government Outputs: Government outputs are valued at the cost of their inputs, as no market prices are available.
    • Inventory Goods: Goods produced but not yet sold are included in GDP as if purchased by the producing firm.
    • Investment Goods: Factories, machines, etc., are considered final products despite being used to produce other goods.

    Items Not Included in GDP

    • Do-it-yourself activities
    • Illegal activities (black market)
    • Purely financial activities (e.g., stock trading)

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    Unit 3 Income & Spending PDF

    Description

    Explore the fundamental components of aggregate demand and supply. This quiz covers consumer expenditure, investment spending, government spending, and net exports. Test your understanding of how these factors influence the economy.

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