macro week 2

• Aggregate output


  The total quantity of goods and services produced in an economy in a given period i.e. real output
• Aggregate income


  The total income received by all factors of production in a given period
• Aggregate output = Aggregate income
• Potential output


  The output the economy would produce if all factors of production were fully employed
• Actual output


  What is actually produced in a given period
• Actual output may diverge from potential output
• Macroeconomic model with fixed prices

  • Prices and wages are fixed
  • Actual output is demand-determined
• Components of aggregate expenditure

  • Consumption C
  • Investment I
• Consumption


  Households' demands for goods and services
• Saving


  That part of its income that a household does not consume in a given period i.e. a flow
• Personal disposable income


  The income households receive from firms plus transfer payments received from the government minus direct taxes
• Consumption function


  The relationship between consumption and disposable income
• Autonomous consumption


  The level of consumption unrelated to income
• Marginal propensity to consume (MPC)


  The fraction of a change in income that is consumed
• Consumption function: C = a + bY
• Saving function


  Shows desired saving at each income level
• Saving function: S = -a + (1-b)Y
• APC + APS = 1
• MPC + MPS = 1
• Investment


  The purchase by firms of physical capital (buildings and equipment) and additions to inventories
• Planned investment


  The additions to capital stock and inventory that are planned by firms
• Aggregate expenditure = Consumption + Investment
• Aggregate expenditure function: AE = (100 + 0.75Y) + 25
• Equilibrium output


  The level of output where planned aggregate expenditure equals actual output
• A change in autonomous demand


  Changes equilibrium income
• Multiplier


  The relationship between a change in autonomous demand and the change in aggregate output
• The multiplier formula is 1/(1-MPC)
• Planned investment


  Investment expenditure that is fixed and does not change when income Y changes
• Autonomous investment


  Investment expenditure that is assumed to not depend on the state of the economy, i.e. independent of the level of output Y
• Aggregate expenditure (AE)


  The amount firms and households plan to spend at each level of income
• Equilibrium output


  Occurs when planned aggregate expenditure AE is equal to actual aggregate output Y
• Equilibrium output determination


  1. Y = AE

  2. Y = a + bY + I

  3. Y = a + I / (1 - b)
• Alternative approach to equilibrium output

  1. S = I

  2. S = -a + (1 - b)Y

  3. I = -a + (1 - b)Y
• Slope of aggregate expenditure schedule depends only on the MPC
• Marginal propensity to consume (MPC)


  How much aggregate consumption expenditure changes when income changes
• Changes in autonomous spending


  Result in shifts of the AE schedule (change in y-axis intercept)
• Multiplier effect


  When there is an increase (decrease) in autonomous expenditure, output increases (decreases) by more than the initial change in autonomous spending
• Multiplier


  The ratio of the change in the equilibrium level of output to a change in autonomous expenditure
• How the multiplier works

  1. Initial increase in AE increases output and income

  2. Increase in income generates increase in consumption

  3. Increase in consumption generates further increase in income and consumption

  4. Process continues until equilibrium is reached at higher output level