Unit 3: Aggregate demand and the multiplier model

Vocabulary flashcards covering key terms from Unit 3: Aggregate demand, GDP measurement, the multiplier, and related concepts.

Gross Domestic Product (GDP)

The market value of all final goods and services produced in a country in a given period; can be measured by expenditure, income, or production/value-added approaches.

Circular flow

A model showing the flow of spending (expenditure), output, and income between households and firms in an economy.

Expenditure approach to GDP

GDP measured as the sum of expenditures: C + I + II + G + (X − M).

Income approach to GDP

GDP measured as the sum of incomes earned by factors of production (wages, profits, etc.).

Production (value-added) approach

GDP measured as the sum of value added by all industries; equals final expenditure.

Nominal GDP

GDP measured at current prices, which can be affected by changes in the price level.

Real GDP

GDP adjusted for inflation; uses base-year prices to measure actual changes in quantity.

Purchasing Power Parity (PPP)

Prices converted to a common standard to compare living standards across countries; reflects relative purchasing power.

GDP components: C, I, II, G, X, M

C: consumption; I: gross fixed capital formation; II: changes in inventories; G: government spending; X: exports; M: imports.

Changes in inventories (II)

The change in unsold goods held by firms; included in investment/expenditure measures of GDP.

Disposable income (Yd)

Income available to households after taxes, used to determine consumption.

Autonomous consumption (c0)

The fixed level of consumption that does not depend on income.

Marginal propensity to consume (MPC, c1)

The change in consumption resulting from a one-unit change in disposable income; slope of the consumption function.

Marginal propensity to save (MPS)

The change in savings from a one-unit change in disposable income; MPS = 1 − MPC.

Aggregate demand (AD)

Total demand for domestically produced goods; in a closed private economy, AD = C + I; in an open economy, AD = C + I + G + NX.

Consumption function (C = c0 + c1Yd)

Relationship showing how consumption depends on disposable income, with autonomous consumption and the MPC component.

Autonomous demand (AD auto)

The portion of aggregate demand that is independent of current income, often c0 + I.

45-degree line

A line on a Y vs AD diagram with slope 1 where AD = Y; points on the line are in equilibrium.

Goods market equilibrium (GME)

Condition where aggregate demand equals output (AD = Y); inventories are unchanged.

Multiplier

The factor by which GDP changes in response to a change in autonomous spending: k = ΔY/ΔAD = 1/(1 − MPC) = 1/(1 − c1).

Equilibrium income with investment (Y*)

In a private economy with C = c0 + c1Y and investment I, Y* = (c0 + I) / (1 − c1).

Investment (I)

Spending by firms on new capital and housing; in the basic multiplier model, I is treated as exogenous (determined outside the model).

Autonomous demand vs induced demand

Autonomous demand is independent of income (c0 + I); induced demand varies with income via the MPC.

Exogenous shock

A change in economic conditions determined outside the model that affects outcomes.

Business cycle

Fluctuations in economic activity: alternating booms and recessions.

Boom

A period of strong economic growth within the business cycle.

Recession (two definitions)

(1) A period of falling real GDP; (2) Two consecutive quarters of negative GDP growth (South Africa uses this definition).

Rule of 70

An approximation for doubling time: doubling time ≈ 70 / annual growth rate.

Real vs nominal GDP difference

Nominal GDP uses current prices; Real GDP uses constant prices (base year) to remove price effects.

Base year

A chosen year whose prices are used to construct real GDP for comparison across years.

GDP per capita

GDP divided by the population; a common measure of average living standards.

Net exports (NX)

Exports minus imports; NX is added in the AD identity for an open economy.

GDP identity in closed economy

Y ≡ C + I + II in a simplified, no-government, no-trade model; at equilibrium, inventory investment II = 0.

Open economy and NX definition

In open economies, GDP = C + I + II + G + (X − M); NX captures foreign trade balance.

Value added approach

GDP equal to the sum of value added at each stage of production; avoids double-counting.

GDP as expenditure interpretation

GDP equals total expenditure on domestically produced final goods and services.