Unit 3 - National Income and Price Determination

Stimulus Package

• A set of laws that provided funding to various programs in order to stimulate growth in an economy.

  • $1 Spending in one area of the economy multiplies into more than $1 spending throughout the economy.

Disposable Income Equation

YD (Disposable Income) = C (Consumption) + S (Savings)

MPC

• (Marginal Propensity to consume): (Change in consumption / Change in disposable income)

  • The MPC is the amount by which consumer spending rises if current disposable income rises by $1 and is the slope of the consumption function.

  • MPC = △ Consumer Spending / △ Disposable Income

Impact of spending money in the economy

• As you keep spending money you cause a chain reaction where many economic actions occur and the economy grows.

MPS

• Amount by which consumer savings rises if current disposable income rises by $1.

  • MPC + MPS = 1

  • C/YD + S/YD = YD/YD

Spending Multiplier

• M = 1/(1-MPC)

• MPC + MPS → M = 1/MPS

Autonomous Change in Aggregate Spending

• The rise or fall in aggregate spending at a given level of real GDP.

  • It’s autonomous (self-governing), whcih means that it is the cause, not the result, of the chain reaction in spending.

Multiplier

• The multiplier is the ratio of the total change in real GDP caused by an autonomous change in aggregate spending to the size of teh autonomous change.

• Multiplier = △Y / △AAS = 1 / (1 - MPC)

(Aggregate) Consumption Function

An equation showing how a household’s consumer spending varies with disposable income.

• When disposable income increases, consumption increases.

• The slope of the line is the MPC
  
  

Sum of all the individual consumption functions in a given economy.

• Consumption (C) = A + (MPC * YD)

  • A = Aggregate autonomous consumer spending

  • MPC = Marginal propensity to consume

  • YD = Aggregate current disposable income

Shifts in the aggregate consumption function

1. Changes in expected future disposable income. If your future income increases, your current consumption increases.

2. Changes in aggregate wealth. If your wealth increases, your current consumption increases.

Consumer Spending vs Investment Spending in Business Cycle

• Although consumer spending is a much larger part of an economy compared to investment spending, changes in investment spending tend to drive the business cycle more.

Planned & Actual Investment Spending

• Planned Investment Spending: The investment spending a business intends to undertake during a given time.

• Actual Investment Spending is equal to planned plus unplanned investment spending.

  • I = I planned + I unplanned.

  • Planned investment might result in unplanned investment as well.

Cost-benefit analysis

• To determine whether a firm should invest money or not, they must do a cost-benefit analysis on the money they are about to spend.

• Cost-benefit Analysis

1. Interest Rate

2. Expected Future Real GDP

3. Current Level of Production Capacity

Cost included in borrowing money

• When a firm considers investment spending, they need to consider the cost included in borrowing money.

• The market interest rate is the cost of investment.

  • Interest rate is the cost of borrowed funds.

  • Interest rate is also the cost of investing your own funds (no borrowing), since it is income foregone.

• There is a negative relationship between interest rate and the dollars of investment spending. If interest rate increases, dollars invested decreases.

Shifts in investment spending

• Expected Future GDP

  • If you expect future GDP to go UP, your current investment spending will also go UP and vice versa.

• Interest Rates

  • If the interest rate go UP, your current investment spending will go DOWN and vice versa.

Tax Multiplier

• It is negative since it takes money out the economy preventing chain reactions.

• -MPC / 1-MPC

• -MPC/MPS

  • If the problem gives you a number (dollars) of taxes multiply it by that to figure out the amount of money not being used in the economy.