exam 2 chapter 9i-10

What is the Nominal Interest Rate?

The stated interest rate on a loan or investment without adjusting for inflation.

What is the Real Interest Rate?

The interest rate adjusted for inflation; reflects true purchasing power.

What is the Inflation Premium?

The portion of the nominal interest rate that compensates for expected inflation.

What does the Consumption Function show?

It shows household spending at different levels of real disposable income.

What are the elements of the Consumption Function Equation?

Autonomous Consumption, Marginal Propensity to Consume (MPC), Disposable Income (DI).

How do you differentiate a change in quantity consumed vs. change in consumption?

Quantity consumed = move along the curve; change in consumption = shift of the curve.

How do consumer expectations affect consumption?

Negative expectations (e.g. recession fears) cause consumption to decrease and shift the curve downward.

How does a change in wealth affect consumption?

More wealth increases spending at any income level, shifting the curve upward.

How does a change in prices affect consumption?

Higher prices reduce purchasing power, shifting the consumption curve downward.

How do interest rates affect consumption?

Lower interest rates increase borrowing and spending, shifting the curve upward.

What is Contractionary Fiscal Policy?

Increase taxes, decrease government spending including transfer payments.

What is a Recessionary Gap?

When actual output is less than potential output.

What is an Inflationary Gap?

When actual output exceeds potential output.

What is Potential Output?

The level of GDP the economy can sustain in the long run.

What do the AD, SRAS, and LRAS curves represent?

AD: total demand; SRAS: short-run aggregate supply; LRAS: long-run aggregate supply.

What are the shifters of the AD curve?

Consumer spending, investment, government spending, net exports.

What are the shifters of the SRAS curve?

Input prices, productivity, legal/institutional environment

What are three effects causing the downward slope of the AD curve?

Wealth effect, interest rate effect, net export effect.

What are the three stages of the SRAS curve?

Keynesian (horizontal), Intermediate (upward-sloping), Classical (vertical).

What do you need to calculate fiscal stimulus needed to close a gap?

Size of the gap and the multiplier.

How does fiscal policy affect Real GDP?

It increases or decreases Real GDP through government spending and taxation adjustments.