Economics: Consumption, Investment, Money, and Business Cycles

Consumption Function

A relationship showing how consumption varies with disposable income.

Autonomous Consumption

Consumption spending that occurs even when income is zero.

Induced Consumption

Consumption that changes as income changes.

Disposable Income (Yd)

Income remaining after taxes are paid.

Marginal Propensity to Consume (MPC)

The fraction of additional income that is spent rather than saved.

Marginal Propensity to Save (MPS)

The fraction of additional income that is saved rather than spent.

Average Propensity to Consume (APC)

Total consumption divided by total income.

Life-Cycle Hypothesis

People plan their consumption across their lifetime, smoothing spending.

Permanent Income Hypothesis

Consumption depends on expected long-term average income.

Wealth Effect

When household wealth rises, consumption increases.

Investment

Spending on capital goods such as machinery, equipment, and buildings.

Capital Stock

The total value of physical capital available in an economy.

Inventory Investment

Changes in the stock of goods firms keep on hand to sell later.

Interest Rate (r)

The cost of borrowing funds or the return on saving.

Expected Future Profitability

The belief about future economic conditions that influences investment decisions.

Business Taxes

Higher taxes decrease investment by lowering after-tax profits.

Investment Demand Curve

Shows the inverse relationship between interest rates and investment spending.

User Cost of Capital

The cost of using capital including interest rates and depreciation.

Financial System

Institutions that transfer funds from savers to borrowers.

Financial Intermediary

An institution, such as a bank, that links savers to borrowers.

Money

Any asset that can be used to purchase goods and services.

Medium of Exchange

Money used to buy and sell goods and services.

Unit of Account

Money used to measure value and record prices.

Store of Value

Money holds purchasing power over time.

M1 Money Supply

Currency + checking deposits.

M2 Money Supply

M1 + savings accounts + time deposits + money market funds.

Fractional Reserve Banking

System where banks hold a portion of deposits and loan the rest.

Required Reserve Ratio

The percentage of deposits banks must hold as reserves.

Money Multiplier

The ratio of money created to the original deposit (1 / reserve ratio).

Nominal Interest Rate

The stated interest rate before adjusting for inflation.

Real Interest Rate

Nominal interest rate minus the inflation rate.

Business Cycle

Recurring pattern of economic expansions and recessions.

Expansion

Period when output, income, and employment are rising.

Peak

The highest point before economic decline.

Recession

Period when output, income, and employment are falling.

Trough

The lowest point before recovery begins.

Potential Output

The economy's maximum sustainable output level.

Output Gap

The difference between actual output and potential output.

Cyclical Unemployment

Unemployment caused by downturns in the business cycle.

IS Curve

Shows combinations of output and interest rates where the goods market is in equilibrium.

MP Curve

Shows how the central bank sets interest rates based on inflation and economic conditions.

Monetary Policy Rule

The guideline a central bank uses when changing interest rates.

Expansionary Monetary Policy

Lowering interest rates to increase output.

Contractionary Monetary Policy

Raising interest rates to slow down the economy.

Fiscal Policy

Government decisions about spending and taxation.

Expansionary Fiscal Policy

Higher government spending or lower taxes that shift the IS curve right.

Contractionary Fiscal Policy

Lower government spending or higher taxes that shift the IS curve left.

IS-MP Equilibrium

The combination of output and interest rates where IS and MP curves intersect.