National Income and Price Determination

Economics

Average Propensity to Consume

Portion of disposable income that is consumed. Consumption / Disposable income.

Average Propensity to Save

Portion of disposable income that is saved. Savings / Disposable income

Marginal Propensity to Consume

Proportion of any change in disposable income that is consumed. Change in consumption / Change in disposable income

Marginal Propensity to Save

Proportion of any change in disposable income that is saved. Change in savings / change in disposable income.

Multiplier

A small change in consumption, investment spending, govt purchases, and net exports leads to an even bigger change in GDP. This determines how large the change will be. 1 / MPS

Aggregate Demand

The amount of real output that buyers collectively desire to purchase at every possible price. Is equal to GDP.

Wealth Effect

A higher price level reduces purchasing power. The public is poorer in real terms. Spending is reduced.

Foreign Purchases Effect

US prices rise compared to foreign prices therefore foreigners buy fewer US goods and Americans buy more foreign goods.

Interest Rate Effect

People need more money so the public increases cash holdings and it reduces funds available for others to borrow (reduces investment spending).

Demand Shock

Shift in the AD curve.

Supply Shock

Shift in the SRAS curve. Price level and output go in opposite directions.

Determinants of aggregate demand

C + I + G + Xn

Determinants of aggregate supply

Change in inputs and productivity.

Long run equilibrium

The economy self corrects and the SRAS and LRAS intersect.

Short run equilibrium

Not producing at the potential or full employment GDP. Inflationary gap, recessionary gap.

Aggregate supply

Shows the level of real domestic output firms will produce at each price level. Positive relationship between price and output. Cost of production is fixed in the short run.

Recessionary gap

Output or actual GDP is less than potential or full employment GDP.

Inflationary gap

Output or actual GDP is beyond potential or full employment GDP.

Equilibrium price level

The point where the quantity of goods or services demanded by consumers equals the quantity supplied by producers in an economy. No excess supply or demand.

Equilibrium real output

The level of economic output (GDP) where aggregate demand equals aggregate supply.

Nominal wage

The amount of money a worker earns, expressed in current dollars without adjusting for inflation.

Sticky wage

Wages resist changing with market conditions, meaning they are slow to adjust downward during economic downturns or upward during upturns.

Potential output

The maximum level of goods and services an economy can sustainably produce with all available resources.

Output gap

The difference between an economy’s actual output and its potential output.