Krugman Economics Ch. 11: Income, Expenditure & Multiplier

What is the multiplier effect in economics?

The multiplier effect describes how an initial change in spending leads to a larger overall change in GDP.

What drives consumer spending according to the consumption function?

Disposable income is the main driver of consumer spending.

What is the difference between planned and unplanned investment?

Planned investment is what businesses intend to invest, while unplanned investment occurs due to actual sales differing from expected sales.

What is the formula for calculating the multiplier?

Multiplier = 1 / (1 - MPC), where MPC is the marginal propensity to consume.

What does MPC stand for and how is it calculated?

MPC stands for marginal propensity to consume, calculated as ΔC / ΔYD, the fraction of an additional dollar of disposable income that is spent.

What is MPS and how is it related to MPC?

MPS stands for marginal propensity to save and is calculated as 1 - MPC.

What is autonomous change in aggregate spending?

It is the initial change in spending at a given level of real GDP.

What happens to GDP when planned aggregate expenditure (AEplanned) is less than GDP?

Unplanned inventory increases occur, leading firms to cut output and GDP falls.

What shifts the aggregate consumption function?

Factors like expected future income and aggregate wealth can shift the consumption function.

What is the Keynesian cross?

A graphical representation of planned aggregate expenditure (AEplanned) against GDP, showing equilibrium where they intersect.

What is the paradox of thrift?

It refers to the situation where if many individuals cut spending simultaneously, it can lead to a greater decline in GDP than the sum of individual cuts.

How does an increase in interest rates affect planned investment?

Higher interest rates typically lead to fewer planned investments as the cost of borrowing increases.

What is the relationship between investment and GDP growth?

Investment drives economic booms and busts; higher planned investment typically indicates expected GDP growth.

What does it mean when inventories pile up?

It indicates that actual sales are lower than expected, leading to unplanned increases in inventories.

What is the significance of the slope of the consumption function?

The slope represents the MPC, indicating how much consumer spending changes with a change in disposable income.

What is the effect of a higher MPS on the multiplier?

A higher MPS results in a smaller multiplier, as more income is saved rather than spent.

What is the formula for planned aggregate spending?

AEplanned = C + Iplanned = A + MPC × GDP + Iplanned.

What is the role of inventories in the economy?

Inventories serve as a buffer to meet future sales; changes in inventories can indicate shifts in production and economic activity.

What happens to GDP when AEplanned exceeds GDP?

Unplanned inventory decreases occur, prompting firms to increase output and GDP rises.

How does consumer confidence affect the consumption function?

Increased consumer confidence can lead to higher expected future income, shifting the consumption function upward.

What is the accelerator principle?

It states that faster GDP growth leads to higher planned investment, while slower growth leads to lower planned investment.

What is the significance of the intercept in the consumption function?

The intercept represents autonomous spending, or the amount spent when disposable income is zero.

What is the impact of exports on autonomous spending?

Exports act like an increase in autonomous spending, boosting overall demand in the economy.

What is the effect of imports on the multiplier?

Imports act as a leak in the economy, reducing the overall impact of the multiplier effect.

What does it mean when the consumption function shifts?

A shift indicates a change in factors other than current income, such as wealth or expectations about future income.

What is the relationship between GDP and unplanned inventory changes?

If GDP is greater than AEplanned, unplanned inventories increase; if GDP is less than AEplanned, unplanned inventories decrease.

What is the formula for the total change in real GDP based on the multiplier?

ΔY* = Multiplier × ΔAAEplanned.

What does a negative unplanned inventory indicate?

It indicates that actual sales were higher than expected, leading to a decrease in inventories.