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Questions and Answers
What three components comprise the GDP in a closed economy?
What three components comprise the GDP in a closed economy?
What does the consumption function imply about disposable income?
What does the consumption function imply about disposable income?
What effect does an increase in the marginal propensity to consume (MPC) have on consumption?
What effect does an increase in the marginal propensity to consume (MPC) have on consumption?
How is the investment function defined in relation to real interest rates?
How is the investment function defined in relation to real interest rates?
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What does the real interest rate measure?
What does the real interest rate measure?
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How is the real interest rate affected by the nominal interest rate and inflation?
How is the real interest rate affected by the nominal interest rate and inflation?
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What is disposable income calculated as?
What is disposable income calculated as?
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Which of the following correctly represents the formula for total income in a closed economy?
Which of the following correctly represents the formula for total income in a closed economy?
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What components are excluded from government spending, G?
What components are excluded from government spending, G?
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What does the term 'market-clearing model' refer to in the context of a closed economy?
What does the term 'market-clearing model' refer to in the context of a closed economy?
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What does the equation Y = C + I + G represent?
What does the equation Y = C + I + G represent?
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What role does the real interest rate play in the investment function?
What role does the real interest rate play in the investment function?
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What economic relationship does S = (Y - T - C) + (T - G) represent?
What economic relationship does S = (Y - T - C) + (T - G) represent?
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In the investment function I = I(r), what does 'r' represent?
In the investment function I = I(r), what does 'r' represent?
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How do fixed values of G and T affect the demand in the goods and services market?
How do fixed values of G and T affect the demand in the goods and services market?
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What effect does an increase in government purchases have on investment?
What effect does an increase in government purchases have on investment?
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Which of the following correctly describes the national income accounts identity relationship derived?
Which of the following correctly describes the national income accounts identity relationship derived?
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How does a tax cut affect disposable income and consumption?
How does a tax cut affect disposable income and consumption?
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What determines whether there is a budget surplus or deficit?
What determines whether there is a budget surplus or deficit?
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What is the relationship between the loanable funds market and the goods market equilibrium?
What is the relationship between the loanable funds market and the goods market equilibrium?
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How is national saving calculated in relation to consumption and government spending?
How is national saving calculated in relation to consumption and government spending?
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What is the relationship between the interest rate and the demand for loanable funds?
What is the relationship between the interest rate and the demand for loanable funds?
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What components make up national saving?
What components make up national saving?
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How does the government influence the supply of loanable funds?
How does the government influence the supply of loanable funds?
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What is the effect of a lower interest rate on household saving behavior?
What is the effect of a lower interest rate on household saving behavior?
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What is private saving defined as?
What is private saving defined as?
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What happens to the equilibrium interest rate when loanable funds demanded exceeds loanable funds supplied?
What happens to the equilibrium interest rate when loanable funds demanded exceeds loanable funds supplied?
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Which of the following describes the effect of expansionary fiscal policy on saving?
Which of the following describes the effect of expansionary fiscal policy on saving?
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The demand for loanable funds primarily originates from which sector?
The demand for loanable funds primarily originates from which sector?
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What is one of the factors that can shift the saving curve?
What is one of the factors that can shift the saving curve?
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An increase in investment demand typically results in which of the following?
An increase in investment demand typically results in which of the following?
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Which of the following is true about a closed economy's output?
Which of the following is true about a closed economy's output?
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What is a common result of a decrease in national saving?
What is a common result of a decrease in national saving?
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Which of the following factors does NOT shift the investment curve?
Which of the following factors does NOT shift the investment curve?
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If the supply of loanable funds is fixed, how does an increase in investment demand affect equilibrium investment?
If the supply of loanable funds is fixed, how does an increase in investment demand affect equilibrium investment?
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What must firms do to take advantage of technological innovations?
What must firms do to take advantage of technological innovations?
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What determines total output in an economy?
What determines total output in an economy?
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Study Notes
National Income and Its Determinants
- The economy's total output and income are determined by the factors of production, specifically capital and labor, and the level of technology.
- The prices of factors of production are determined by their marginal product, meaning the additional output generated by employing one more unit of the factor.
- Total income is distributed based on the contributions of each factor, with labor income and capital income comprising the majority of national income.
- The demand for goods and services is driven by three components: consumption (C), investment (I), and government spending (G).
The Goods Market: Demand and Supply
- The national income accounts identity provides a framework for understanding the components of GDP: Y = C + I + G.
- Consumption (C) is influenced by disposable income (Y-T), which is income after taxes and transfer payments.
- The consumption function, often expressed as C = a + b(Y-T), demonstrates the relationship between consumption and disposable income, where 'a' represents autonomous consumption and 'b' represents the marginal propensity to consume (MPC).
- The MPC measures the change in consumption for each additional dollar of disposable income; for instance, if the MPC is 0.8, households spend $0.80 of each additional dollar on consumer goods and services.
- Investment (I) is positively associated with the real interest rate (r), reflecting the cost of borrowing and the opportunity cost of using one's own funds for investment.
- Government spending (G) is assumed to be exogenous, meaning it's determined by policymakers and not affected by other economic variables.
- Taxes (T) are also assumed to be exogenous.
Equilibrium in the Goods and Services Market
- The equilibrium in the goods market occurs where the quantity of goods and services supplied (Y) equals the quantity demanded (C + I + G).
- The real interest rate (r) adjusts to ensure this balance by affecting the demand for investment, a key component of overall demand.
The Loanable Funds Market: Supply and Demand
- The Loanable Funds market represents the market for borrowing and lending.
- The demand for loanable funds primarily stems from investment, as firms borrow to finance capital expenditures and consumers borrow for housing purchases.
- The supply of loanable funds comes from national saving, which consists of private saving (Y-T-C) and public saving (T-G).
- Private saving represents what households save after consuming, while public saving represents the government's surplus when tax revenue (T) exceeds spending (G).
- The equilibrium interest rate (r) in the loanable funds market reflects the balance between the demand for and supply of loanable funds.
Factors Affecting Saving and Investment:
- Shifts in the saving curve are driven by changes in public saving (through fiscal policy adjustments) and private saving (influenced by consumer preferences, tax incentives, and 401(k) and IRA savings).
- Shifts in the investment curve are primarily driven by technological innovations and tax incentives specifically designed to encourage investment.
Impact of Changes in Saving and Investment
- An increase in government purchases (ΔG) leads to a decrease in investment due to the crowding-out effect, raising interest rates.
- A decrease in taxes (ΔT) increases disposable income, boosting consumption and decreasing national saving.
- An increase in investment demand, with a fixed supply of loanable funds, will lead to higher interest rates.
The Special Role of the Real Interest Rate (r)
- The real interest rate plays a critical role in connecting the goods market and the loanable funds market.
- When the loanable funds market is in equilibrium (saving equals investment), the goods market is also necessarily in equilibrium.
- This highlights the interconnected nature of the economy, with the real interest rate acting as a key equilibrating factor across different markets.
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Description
Explore the factors that influence national income and its distribution through different components such as consumption, investment, and government spending. This quiz covers essential economic principles and equations that govern the goods market, including the national income accounts identity.