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EC140 Lecture Notes - Lecture 6: Consumption Function, Interest Rate, Aggregate Demand

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emilyhawkinsss
23 Jan 2019
School
WLU
Department
Economics
Course
EC140
Professor
David R. Johnson

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EC140 Lecture Notes - Lecture 6: Consumption Function, Interest Rate, Aggregate Demand

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Document Summary

An increase in wealth increases consumption at each level of disposable income. An increase in expected future income reduces consumption at each level of disposable income. An increase in expected future income increases consumption at each level of disposable income. The text reports that a one billion dollar increase in total wealth of households is estimated to increase consumption by million. Houses are the largest components of household wealth. Inventory accumulation inventories are goods held awaiting sale or goods held as part of production (-2 to +2% of gdp) Residential construction building new homes (both owner occupied and not)(5- New plant and equipment new capital created by business sector for future production (10-20% of gdp) Since inventory is tying up money either money borrowed or money that could be earning interest . If interest rates were to increase firms would hold less less inventory.

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Related Questions

Specific assignment: Mark each statement either True or False. If a statement is false, explain (very briefly) why it is false.

Keynes hypothesized that consumption is positively related to income. True

The marginal propensity to consume, MPC, is measured as changes in consumption over changes in income. True

The MPC is merely the percent of one’s income that is spent to purchase goods and services. True

The MPC is the slope of the consumption function.

If the MPC is .8, then it may be concluded that the MPS must be .2.

If a person’s income is $10,000 and that person is spending $7,500 on consumption, then it may be concluded that that person has a marginal propensity to save of .25.

The MPC and the MPS must sum to one, meaning that 1 – MPC = MPS

Given a linear (straight-line) consumption function, the MPC must be a constant.

At the point graphically at which the consumption function intersects the 45-degree reference line, the MPC must be equal to 1.

If the consumption function lies above the 45-degree reference line, then there must be negative saving in the economy.

Autonomous consumption is that level of consumption spending that is independent of the level of income.

A change in the level of income will shift the consumption function either upward or downward.

A change in the level of consumer wealth will shift the consumption function either upward or downward.

If the MPC has a positive value, then the MPS must have a negative value.

Saving is defined simply as disposable income minus consumption.

If the consumption function has a slope of 4/5, then the saving function must have a slope of .2.

Any factor that would shift the consumption function upward would shift the saving function upward also.

The average propensity to consume (APC), like the MPC, is simply the slope of the basic, Keynesian consumption function.

Given a typical shaped consumption function, as the level of income rises, the APC rises as well.

If a consumption function graphically starts at a point above the origin (i.e., has a positive vertical axis intercept), then the saving function must begin below the origin.

A dramatic rise in household inflationary expectations could be expected to shift the consumption function downward and the saving function upward.

1. The multiplier helps explain

   

A. why a decrease in taxes causes real Gross Domestic Product (GDP) to fall by more than the amount of the decrease in taxes.
   

B. why a fall in investment cause real Gross Domestic Product (GDP) to rise by more than the amount of the decrease in investment.
   

C. why a rise in government expenditures causes real Gross Domestic Product (GDP) to rise by more than the amount of the increase in government spending.
   

D. why an increase in disposable income causes real Gross Domestic Product (GDP) to rise by less than the amount of the increase in disposable income.

 

2. If the marginal propensity to save (MPS) increases, the multiplier

   

A. decreases.
   

B. can either increase or decrease, depending on what happens to the marginal propensity to consume (MPC).
   

C. stays the same.
   

D. increases.

 

QUESTION 60

The investment function will shift when there is a change in

   

A. the opportunity cost of retained earnings.
   

B. firms' profit expectations.
   

C. the cost of borrowing.
   

D. the interest rate.

1.43 points

QUESTION 61

In the Keynesian model, whenever planned saving exceeds planned investment,

   

A. there will be unplanned inventory accumulation.
   

B. real GDP will not be influenced.
   

C. the interest rate will remain unchanged.
   

D. there will be unplanned inventory depletion.

 

1.43 points

QUESTION 62

In the Keynesian model, whenever planned saving is less than planned investment,

   

A. there will be unplanned inventory depletion.
   

B. the interest rate will remain unchanged.
   

C. there will be unplanned inventory accumulation.
   

D. real GDP will not be influenced.

 

1.43 points

QUESTION 63

Government purchases

   

A. are determined by the political process.
   

B. are determined by the public.
   

C. are influenced by interest rates.
   

D. are determined by suppliers.

 

1.43 points

QUESTION 64

If, at some level of output, total planned real expenditures are less than real Gross Domestic Product (GDP),

   

A. real GDP will either fall or remain unchanged, depending on the MPC.
   

B. real GDP will rise.
   

C. real GDP remains unchanged.
   

D. unplanned inventories will increase and real GDP will fall.

 

1.43 points

QUESTION 65

When the economy is operating at the equilibrium level of GDP, we know that

   

A. total planned real expenditures equal real GDP.
   

B. real net exports equal inventory changes.
   

C. planned real investment spending equals real net exports of zero.
   

D. total planned real consumption expenditures equal real GDP.

 

1.43 points

QUESTION 66

One divided by the marginal propensity to save (MPS) is the formula for

   

A. the inverse of the multiplier.
   

B. the multiplier.
   

C. one minus the multiplier.
   

D. autonomous consumption.

 

QUESTION 67

Thinking like an economist would, which is true of investment?

   

A. Investment represents spending on capital goods.
   

B. Investment is a stock concept.
   

C. Investment is putting money into stocks and bonds.
   

D. It is the portion of disposable income that is not used for consumption or saving.

 

QUESTION 68

Other things being equal, if input prices rise in a country, then there would be

   

A. cost-push inflation.
   

B. demand-pull inflation.
   

C. cost-pull deflation.
   

D. more production and a lower price level.

 

QUESTION 69

In the short run, if the price level rises, then the overall economy can temporarily produce beyond its nominal capacity. One reason for this is that

   

A. existing capital equipment can be used more intensively.
   

B. wage rates rise almost simultaneously with the price level.
   

C. the unemployment rate usually rises dramatically along with the price level.
   

D. workers can be switched from counted to uncounted production.

In the country of Utopia, the structure of the economy is described as the following:

Y = C + I + G + (X – M)

C = C0 + (mpc)(DI)

I = I0 + (mpi)(Y)

M = M0 + (mpm)(DI)

DI = Y – T

T = (t)(Y)

Where Y is the level of real GDP in the economy, DI denotes the disposable income in the economy, C represents the level of consumption in the economy, C0 is the autonomous consumption level, mpc denotes the marginal propensity to consume, I is the level of investment in the economy, I0 characterizes the autonomous investment, mpi is the marginal propensity to invest, G characterizes the level of government expenditure, X is the level of export from the country, M represents the amount of import in the country, M0 is the level of autonomous import, mpm denotes the marginal propensity to import, T is the amount of tax imposed in the country, and t represents the average tax rate in the economy.

After extensive research, the economists in Utopia believe that the following values (all the dollar values are in number of millions) can be assigned to the structure of the economy, C0 = $500; mpc = 0.8; I0 = $200; mpi = 0.2; G = $400; X = $300; M0 = $100; mpm = 0.1; and t = 0.25. The Utopian economists further believe that the level of potential GDP in the country is $4,000.

Questions:

1. What is the demand side equilibrium level of real GDP in the country? Please show your calculations.

2. Is the overall Utopian economy in equilibrium? Elaborate your answer.

3. If the economy is not in equilibrium, what will happen eventually? Explain your answer.

4. What is the value of the overall multiplier? Please show your calculations and explain the value.

The country of Utopia is probably experiencing a recessionary pressure in its economy now. The economists are suspecting that, since the latest estimates of mpc, mpi, and mpm indicate that their estimated values have gone down to 0.65, 0.15, and 0.05 respectively.

5. What is the demand side equilibrium level of real GDP in the country now? Please show your calculations.

6. Is the overall Utopian economy now in equilibrium? Elaborate your answer.

7. If the economy is not in equilibrium now, what will happen eventually? Explain your answer.

8. What is the adjusted value of the overall multiplier? Please show your calculations and explain the value.