ECON TEST 3

Microsoft Encarta

Bundled physical encyclopedia with the internet, precursor to the WWW, allowed purchasing a computer with the encyclopedia instead of costly books, example of creative destruction.

Trade deficit

Situation where imports exceed exports.

GDP Components

GDP = Consumption + Investment + Government + Nx (exports - imports).

Multiplier Effect

Change in spending leads to a larger change in real GDP, not necessarily equal.

Consumption

Primarily determined by direct income, direct relationship with income, consumption schedule, saving schedule, "dissavings."

Average Propensities

APC (Average Propensity to Consume) and APS (Average Propensity to Save) sum up to 1

APC (Average Propensity to Consume)

fraction of total income consumed

Total consumption divided by total income

APS (Average Propensity to Save)

fraction of total income saved

Marginal Propensity

MPC (Marginal Propensity to Consume) and MPS (Marginal Propensity to Save) sum up to 1.

MPC (Marginal Propensity to Consume)

change in consumption/change in income

Change in consumption divided by change in income

MPS (Marginal Propensity to Save)

change in saving/change in income

Investment Demand

Influenced by acquisition costs, taxes, technological changes, capital goods, inventory changes, and expectations.

Classical Model

Assumes flexible wages and prices, rational self-interest, and markets self-adjust; contrasts with Keynesian economics.

Equilibrium GDP

Savings equal planned investment.

Aggregate Demand

slopes downwards due to real balance, interest, and foreign purchases effects

Determined by factors such as consumption, investment, government spending, and net exports

Aggregate Supply

in the short run is fixed

determined by factors such as labor market conditions, technological changes, and input prices

Productivity

Real output per unit of input, influenced by legal changes, taxes, subsidies, and government regulations.

Fiscal Policy

Involves changes in government spending, taxes, and regulations to achieve economic goals.

Managed by the government

Monetary Policy

Managed by central banks.

Involves controlling interest rates and money supply to influence economic activity.

Contractionary Policy

lowers GDP to control inflation

Intended to reduce inflationary pressures

Involves decreasing government spending or increasing taxes.

Expansionary Policy

boosts GDP for growth

Intended to stimulate economic growth

Involves increasing government spending or decreasing taxes

Deficit

spending exceeds revenue

government spending exceeds revenue in a fiscal year

Surplus

when revenue exceeds spending

government revenue exceeds spending in a fiscal year

Full Employment

No cyclical unemployment, only frictional and structural unemployment.

Keynesian Model

Assumes sticky prices and wages.

Believes in the possibility of involuntary unemployment.

Advocates for government intervention to stabilize output and employment.

Saving

Occurs when income exceeds consumption

Dissaving

Occurs when consumption exceeds income, typically financed by reducing savings or borrowing

Consumption Function

Describes the relationship between disposable income and consumption.

Implications: Higher disposable income generally leads to higher consumption, but at a diminishing rate

Stronger Currency

Decreases net exports (exports - imports).

Can lead to a decrease in GDP due to reduced exports.

Weaker Currency

Increases net exports.

 Can lead to an increase in GDP due to higher exports.

Crowding-Out Effect

Occurs when increased government borrowing (to finance deficits) leads to higher interest rates, reducing private sector investment.

Increase government spending to kickstart the economy

Advocates for increased government spending during economic downturns to stimulate aggregate demand.

Inflationary Pressures

If spending exceeds the economy's capacity to produce (full employment GDP), it can lead to inflation.