Chapter 12: Aggregate Expenditure And Output In The Short Run

Front 1

Define: Aggregate Expenditure and its model.

Back 1

Total spending in the economy: the sum of consumption, planned investment, government purchases and net exports

Aggregate Expenditure Model: a study of the short-term interaction between the aggregate expenditure and real GDP, assuming that price level is constant.

Front 2

Define: inventory.

Back 2

Unsold produced units.

Front 3

When is macroeconomic equilibrium achieved? Regarding its components and employment?

Back 3

When total aggregate expenditure, AE equals total production, GDP.

This occurs when consumption is equal to production, which creates no incentives or disincentives to change production; and therefore employment.

Front 4

What are the four components of aggregate expenditures? Are they real or nominal?

Back 4

1. Consumption

2. Planned Investment

3. Government Spending

4. Net Exports

They are adjusted for inflation.

Front 5

What happens when aggregate expenditure is higher than GDP?

Back 5

Inventories will decline because consumption is greater than production. This causes both GDP and employment to increase.

Front 6

What are the five components of consumption?

Back 6

1. Current Disposable Income

2. Household Income

3. Expected Future Income

4. The Price Level

5. The Interest Rate

Front 7

When can current income explain current consumption well? Why is this?

Back 7

Only when current income is not unusually different than expected future income because people will follow a pattern of spending assuming that income is expected to be stable.

Front 8

If prices increase for a product, what happens to aggregate consumption?

Back 8

It may not necessarily change because it may not be representative of the economic price level.

Front 9

What is the effect of a high interest rate on consumption? Are people interested on the real or nominal rate? Why?

Back 9

Increases incentives to save and decrease spending.

The real rate as people are concerned with the actual spending power.

Front 10

Define: consumption function

Back 10

The relationship between consumption and the disposable income.

Front 11

Define: marginal propensity to consume and save. What is their relationship?

Back 11

Consume: the slope of the consumption function.

Save: the amount by which savings increase when disposable income increases.

They both must equal one given that there are no change in taxes because what is left from spending is consumed.

Front 12

Formula: national income

Back 12

Disposable Income + Net Taxes

Front 13

What are the four variables affecting planned investment?

Back 13

1. Expectations of Future Profitability

2. Interest Rate

3. Taxes

4. Cash Flow

Front 14

What are the three factors affecting net exports?

Back 14

1. Relative price levels. I.e. inflation rate

2. Relative economic growth rates

3. Exchange rate

Front 15

What will happen to net exports if economic growth is faster than others? Why?

Back 15

It will cause it to drop because income is rising faster; and therefore increase foreign consumption relatively faster as well.

Front 16

Define: 45° line

Back 16

The line representing macroeconomic equilibrium, where aggregate expenditure (spending) equals GDP (production)

Front 17

Why is the aggregate expenditure line linear?

Back 17

Because all other variables apart from consumption is assumed to be constant.

Front 18

What occurs when aggregate expenditure is different from equilibrium?

Back 18

Production and consumption will continuously change because of the changes in inventory, until it reaches equilibrium.

Front 19

What is the ideal point of macroeconomic equilibrium? Why?

Back 19

When it occurs at potential GDP as firms operate at their normal capacity and cyclical unemployment is zero or there is full employment.

Front 20

At any point, what is the difference between the aggregate expenditure line and the 45° line?

Back 20

Change in inventory

Front 21

By view of the aggregate expenditure model, when can an economy experience recession?

Back 21

When the Keynesian cross is less than the potential GDP.

Front 22

What is a key difference between aggregate expenditure and GDP?

Back 22

Actual consumption spending and planning as all other components are assumed to be constant.

Front 23

Formula: unplanned change in inventory

Back 23

Real GDP (Y) - Planned aggregate expenditure (AE)

Front 24

Define: multiplier effect

Back 24

The process by which an autonomous expenditure leads to a larger increase in real GDP.

Front 25

Define: autonomous expenditure. Example?

Define: multiplier

Back 25

Expenditures which does not depend on the level of GDP. I.e. constants

The ratio of increase of equilibrium real GDP to the increase of autonomous expenditure

Front 26

Formula: multiplier. Two formulas.

Back 26

1. Change in equilibrium real GDP / Change in autonomous expenditure

2. (1 - M)^-1

Front 27

What happens when the price level changes? Why?

Back 27

If prices rise, aggregate expenditures will fall due to the changes in its variables (e.g. consumption, investment and net exports) and vice-versa.

Front 28

Given a multiplier m and a change in autonomous expenditure, what is the new macroeconomic equilibrium of real GDP?

Back 28

m * Change in autonomous expenditure + the old equilibrium.

Front 29

What is John Maynard Keynes' argument regarding saving?

Back 29

People in an economy will be worse off by saving as a result of lowering the aggregate expenditure, which causes a recession.

Front 30

Aside from the slop of the AE, what are the formulas for calculating the marginal propensity to consume?

Back 30

The ratio of the change in consumption to the change in national income or disposable income.

Front 31

If stocks rise, what will happen to consumption?

Back 31

Consumption will increase as stocks will increase household wealth; and therefore increase consumption.

Front 32

Formula: change in national income

Back 32

Sum of changes in consumption, saving and taxes

Front 33

Why will an increase in autonomous expenditures have a multiplied effect?

Back 33

1. By increasing the aggregate spending in an economy, disposable income increases, which causes consumption to increase and inventories to fall.

2. Production increases as a result as well along with consumption.

3. Eventually, it reaches a new equilibrium which is much higher than the old one.