Macroeconomic Concepts: Consumer Spending
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Questions and Answers

If the MPC is 0.8, what is the value of the spending multiplier?

  • 5 (correct)
  • 1.25
  • 0.2
  • 0.8

Which of the following would most likely cause a shift upward in the aggregate consumption function?

  • A decrease in government transfers
  • A decrease in expected future disposable income
  • An increase in current taxes
  • An increase in aggregate wealth (correct)

Suppose the MPC is 0.75. If the government increases taxes by $200 billion, what is the approximate change in the overall GDP?

  • Decrease of $600 billion (correct)
  • Decrease of $800 billion
  • Increase of $600 billion
  • Increase of $800 billion

If actual sales are less than expected sales, which of the following is most likely to occur?

<p>Unplanned inventory investment will be positive (D)</p> Signup and view all the answers

What does 'disposable income' refer to?

<p>Income after taxes are paid and government transfers are received (C)</p> Signup and view all the answers

A firm is considering a new project. Which of the following factors would most likely discourage the firm from pursuing the project?

<p>High current production capacity (C)</p> Signup and view all the answers

If the marginal propensity to consume (MPC) is 0.6 and disposable income increases by $1000, by how much will consumer spending increase?

<p>$600 (B)</p> Signup and view all the answers

Assume the MPC is 0.8. By how much would autonomous spending need to decrease to offset an initial increase in real GDP of $500 billion?

<p>$100 billion (A)</p> Signup and view all the answers

If consumer confidence increases, leading to greater optimism about future economic conditions, what is the likely short-term impact on the aggregate demand (AD) curve?

<p>The AD curve will shift to the right, indicating increased aggregate demand. (A)</p> Signup and view all the answers

Which of the following scenarios would most likely cause a shift in the aggregate demand curve?

<p>The government increases its spending on infrastructure projects, without changing taxes. (B)</p> Signup and view all the answers

How does the interest rate effect explain the negative slope of the aggregate demand curve?

<p>As the aggregate price level falls, the demand for money decreases, leading to lower interest rates and increased investment. (C)</p> Signup and view all the answers

What is the primary reason that nominal wages are considered 'sticky' in the short run?

<p>Labor contracts and agreements often fix wages for a specific period, preventing immediate adjustments. (B)</p> Signup and view all the answers

If the aggregate price level increases but production costs remain constant in the short run, what is the likely effect on firms' output?

<p>Firms will increase output due to higher potential profits. (D)</p> Signup and view all the answers

Consider an economy where the size of the existing physical capital stock is already very large. How might this affect firms' planned investment spending, and consequently, the aggregate demand?

<p>Firms will likely decrease investment spending as they have sufficient capital, decreasing aggregate demand. (B)</p> Signup and view all the answers

How do changes in net exports contribute to the downward slope of the aggregate demand curve?

<p>As the domestic price level rises, domestic goods become relatively more expensive, decreasing net exports and aggregate demand. (A)</p> Signup and view all the answers

If the government increases taxes while holding government spending constant, what is the most likely short-term impact on the aggregate demand (AD) curve?

<p>The AD curve will shift to the left, indicating decreased aggregate demand. (A)</p> Signup and view all the answers

How does an increase in commodity prices typically affect the short-run aggregate supply (SRAS) curve, and why?

<p>Shifts SRAS to the left because higher input costs increase production costs. (C)</p> Signup and view all the answers

If workers expect a significant increase in inflation, how will this expectation likely impact the short-run aggregate supply (SRAS) curve?

<p>SRAS will shift to the left, as higher wage demands increase production costs. (B)</p> Signup and view all the answers

What is the defining characteristic of the Long-Run Aggregate Supply (LRAS) curve, and what does it represent?

<p>Vertical; represents the potential output when all prices, including nominal wages, are fully flexible. (A)</p> Signup and view all the answers

Which factor would cause a shift in the Long-Run Aggregate Supply (LRAS) curve?

<p>Technological advancements. (D)</p> Signup and view all the answers

Consider an economy in short-run equilibrium. What characterizes this state?

<p>The point where aggregate demand equals short-run aggregate supply, determining the short-run equilibrium price level and output. (C)</p> Signup and view all the answers

What is a 'negative supply shock,' and what is its immediate impact on the economy?

<p>An event that shifts the SRAS curve to the left, decreasing output and increasing the price level. (C)</p> Signup and view all the answers

What economic condition is characterized by a combination of higher prices and lower GDP, and what term is used to describe it?

<p>Stagflation; characterized by increasing prices and decreasing GDP. (C)</p> Signup and view all the answers

If the current aggregate output is below the potential output, what type of gap exists, and what does this imply for the economy?

<p>Recessionary gap; implies the economy is operating below its sustainable capacity. (C)</p> Signup and view all the answers

What is the primary goal of stabilization policy, and how is it typically implemented?

<p>To reduce the severity of recessions and rein in strong expansions; implemented through government policies. (A)</p> Signup and view all the answers

If a negative supply shock occurs, what are the likely consequences, and why are they challenging for policymakers to address?

<p>Higher unemployment and increased inflation, presenting a difficult trade-off for policymakers. (B)</p> Signup and view all the answers

How do government purchases of goods and services directly and indirectly impact GDP?

<p>Directly boost GDP and indirectly boost it further through the spending multiplier. (A)</p> Signup and view all the answers

Why do government transfers have a smaller impact on shifting the AD curve compared to government purchases?

<p>Because only a portion of transfers is spent (due to the MPC) rather than saved, affecting the multiplier effect. (D)</p> Signup and view all the answers

In the context of fiscal policy, what is the tax multiplier, and how is it calculated?

<p>The factor by which a change in tax collections changes real GDP; calculated as -MPC/(1-MPC). (A)</p> Signup and view all the answers

What are 'automatic stabilizers,' and how do they function within an economy?

<p>Government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and contractionary when it expands. (B)</p> Signup and view all the answers

What is discretionary fiscal policy, and how does it differ from automatic stabilizers?

<p>Fiscal policy that is the result of deliberate actions by policymakers, unlike automatic stabilizers. (A)</p> Signup and view all the answers

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Flashcards

MPC

Marginal Propensity to Consume; the increase in consumer spending when disposable income rises by $1.

MPS

Marginal Propensity to Save; the increase in household savings when disposable income rises by $1.

Spending Multiplier

It measures the total change in real GDP from an initial change in aggregate spending; calculated as 1/(1-MPC).

Tax Multiplier

The effect of a change in taxes on real GDP; calculated as -MPC/(1-MPC).

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Consumption Function

Shows how household consumer spending varies with current disposable income.

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Investment Spending

Planned investment spending is the investment that businesses intend to undertake, affected by rates and GDP expectations.

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Inventory Investment

Change in inventories held in the economy; unplanned if actual sales differ from expected sales.

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Autonomous Change in Spending

An initial rise or fall in aggregate spending that spurs subsequent income and spending changes.

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Aggregate Demand Curve

Shows the relationship between aggregate price level and quantity of output demanded.

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Wealth Effect

Change in consumer spending due to altered purchasing power of assets.

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Interest Rate Effect

Change in investment and consumer spending from altered interest rates.

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Net Export Effect

Change in net exports caused by changes in domestic currency value.

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Short-Run Aggregate Supply Curve

Shows the positive relationship between aggregate price level and quantity of output supplied in the short run.

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Sticky Wages

Wages that do not change immediately with price level changes.

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Profit per Unit of Output

Profit is the difference between price per unit and production cost per unit.

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Shifts in Aggregate Demand

Changes in consumer and firm optimism, wealth, and government policy affecting aggregate spending.

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SRAS Shift

Short-run Aggregate Supply curve changes due to various factors.

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Commodity Prices

Rising prices of inputs that lead to leftward SRAS shifts.

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Nominal Wages

Changes in nominal pay that affect SRAS shifts: rise shifts left, fall shifts right.

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Productivity Changes

Increased productivity allows more output with the same inputs, shifting SRAS right.

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Inflation Expectations

Expecting higher inflation leads workers to demand higher wages, shifting SRAS left.

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LRAS

Long-Run Aggregate Supply shows potential output with fully flexible prices.

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Potential Output

Level of real GDP produced at full resource employment.

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Demand Shock

A sudden event causing a shift in the AD curve due to changes in overall demand.

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Stagflation

A situation with rising prices and falling GDP.

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Recessionary Gap

When aggregate output is below potential output.

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Fiscal Policy

Government actions altering spending and taxation to influence the economy.

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Automatic Stabilizers

Fiscal policies that automatically adjust to economic changes without new laws.

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Government Transfers

Payments made by the government to individuals or families for economic support.

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Balanced Budget Multiplier

Effect on real GDP from simultaneous changes in government spending and taxes.

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Study Notes

Section 4: Macroeconomic Concepts

  • Consumer Spending (C): Typically two-thirds of GDP
  • Disposable Income: Income after taxes and government transfers
  • Consumption Function: Illustrates how consumer spending relates to current disposable income; the slope is the MPC
  • MPC (Marginal Propensity to Consume): Change in consumer spending / Change in disposable income; Represents the increase in spending when disposable income rises by $1.
  • MPS (Marginal Propensity to Save): Increase in saving when disposable income rises by $1; MPC + MPS = 1
  • Aggregate Consumption Function: This function illustrates the dynamic connection between the level of current disposable income available to households and the extent of consumer spending within the overall economy. It signifies how variations in income influence the purchasing behavior of consumers, which is critical for understanding economic fluctuations.
    • The formula used to calculate this relationship is: Aggregate consumer spending = Consumer spending at zero disposable income + Marginal Propensity to Consume (MPC) * Aggregate current disposable income. The MPC reflects the proportion of additional income that will be spent on consumption rather than saved, highlighting its crucial role in driving economic growth.
  • Shifts in Aggregate Consumption Function: These shifts are influenced by various factors, notably changes in anticipated disposable income over the coming periods, which refers to the income available to households after taxes, as well as alterations in overall wealth held by consumers, impacting their spending behaviors accordingly.
  • Investment Spending: Spending by businesses on capital goods.
    • Factors influencing planned investment spending include interest rates, expected future GDP, and current production capacity. Lower interest rates and higher expected future GDP stimulate planned investment spending.
    • Inventory Investment: Change in the level of inventories held by businesses.
      • Unplanned inventory investment occurs when actual sales differ from expected sales, leading to changes in the level of inventories.
      • Total inventory investment = Planned investment + Unplanned investment.
  • Spending Multiplier: Ratio of the total change in real GDP to an autonomous change in aggregate spending. 1 / (1 - MPC)
  • Autonomous: Refers to entities making independent decisions and actions, often in economic contexts such as investment or consumption. Change in Aggregate Spending: An initial change in spending that is a cause, rather than a result of, a series of income and spending changes.
  • Aggregate Demand Curve: Displays the relationship between aggregate price level and quantity of aggregate output demanded.
    • Downward sloping due to the real wealth effect, interest rate effect, and net export effect.
    • Real Wealth Effect: Changes in consumer spending due to changes in the purchasing power of assets.
    • Interest Rate Effect: Changes in investment and consumer spending due to changes in interest rates caused by shifts in demand for money.
    • Net Export Effect: Shift in net exports caused by changes in the domestic currency's value, affecting the relative prices of domestic and foreign goods.
  • Shifts in Aggregate Demand: Driven by changes in expectations, wealth, the existing physical capital stock, and government policies (fiscal and monetary).
  • Aggregate Supply Curve: Relationship between aggregate price level and quantity of aggregate output supplied.
    • Short-Run Aggregate Supply (SRAS) Curve: Positively sloped; Profit per unit of output = Price per unit of output - Production cost per unit of output. Higher prices lead to higher short-run profitability, encouraging producers to supply more.
  • Shifts in SRAS: Caused by changes in commodity prices, nominal wages, productivity, and expectations about inflation.
    • Higher commodity prices, nominal wages, and expected inflation shift SRAS to the left; higher productivity shifts SRAS to the right.
  • Long-Run Aggregate Supply (LRAS) Curve: Vertical; represents the relationship between aggregate price level and quantity of aggregate output supplied when all prices (including nominal wages) are flexible.
  • Potential Output: Level of real GDP when all resources are fully employed.
  • Shifts in LRAS: Driven by changes in the quantity and quality of resources and technological change.
  • AD-AS Model: Combines AD and AS curves to analyze macroeconomic fluctuations.
  • Short-Run Macroeconomic Equilibrium: Exists when the aggregate quantity of output demanded equals the aggregate quantity of output supplied.
  • Demand Shocks: Shifts in aggregate demand. Positive demand shocks increase aggregate demand (shift AD right); Negative shocks decrease aggregate demand (shift AD left).
  • Supply Shocks: Shifts in aggregate supply. Positive shocks shift SRAS to the right; negative shocks shift SRAS to the left.
    • Stagflation: Combination of higher prices and lower GDP due to negative supply shocks.
  • Recessionary Gap: Aggregate output falls below potential output.
  • Inflationary Gap: Aggregate output rises above potential output.
  • Fiscal Policy: Government spending and taxation to counteract macroeconomic fluctuations.
    • Expansionary Fiscal Policy: Increases government purchases, reduces taxes, or increases government transfers to raise aggregate demand.
    • Contractionary Fiscal Policy reduces gov purchases, increase taxes, reduce gov transfers.
  • Automatic Stabilizers: Policies (government spending and taxation) automatically expand when the economy contracts and vice-versa.
  • Taxes and Government Spending: Direct and multiplier effects of government purchases on GDP; taxes and transfers have different multiplier effects compared to government purchases.
  • Government Budget and Total Spending: Flow of funds into and out of the government.
  • Balanced Budget Multiplier: How a simultaneous change in both spending and taxes impact real GDP.

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  • A video overview is also linked.

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Explore consumer spending and its relationship to disposable income. Understand the consumption function, MPC (Marginal Propensity to Consume), and MPS (Marginal Propensity to Save). Learn how shifts in the aggregate consumption function impact the economy.

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