Aggregate Expenditure and IS-MP Curve

Quiz 3 Flashcards

What is the Aggregate Expenditure Model?

Measures the total goods and services households, firms, and the gov. plan or want to buy across the whole economy

Simple Aggregate Expenditure Model?

Aggregate Expenditure = Consumption (C) + Ip (Planned Investment)

How is Planned Investment different from Investment typically?

Planned Investment is the amount firms intend to spend on capital and inventory. Actual Investment is what they actually spend, including unplanned changes in inventories (often due to unexpected sales).

Simple Aggregate Expenditure at equilibrium?

Y=AE=\frac{1}{1-b}\cdot a+Ip

b = marginal propensity to consume (MPC)

a = autonomous consumption (y-intercept of consumption function) 
(1/1-b) = the simple expenditure multiplier 

Ip= Planned Investment

What is the multiplier effect for the Simple Aggregate Expenditure Model?

\frac{\Delta Y}{\Delta Ip} _p = \frac{1}{1-b}

What is the Consumption Function?

Shows the relationship between consumption spending by households and the level of disposable income.

What is the equation for the Consumption Function?

C=a+b\cdot Y

C = Consumption Spending

a = Autonomous Consumption

b = Marginal Propensity to Consume

Y = disposable income

How to calculate Marginal Propensity to Consume?

b = \text{MPC} = \frac{\Delta C}{\Delta Y_d}

What is Autonomous Consumption?

The amount of consumption that would occur even if disposable income was at zero. Funded by savings or borrowing.

Version 2 of Aggregate Expenditure Model?

Aggregate Expenditure=C+Ip+G

G = Government Purchases 

What is the Consumption Function under Version 2 of the AE Model (Gov. Purchases, given lump-sum taxes)

C = a + b (Y - T)

C = Consumption Spending

a = Autonomous Consumption

b = Marginal Propensity to Consume

Y = Disposable Income
T= Taxes

What is Version 2 of the Aggregate Expenditure Model at Equilibrium? 

Y = (1/1-b) (a + Ip + G - bT) 

What is the multiplier effect for Version 2 of the Aggregate Expenditure Model (given a lump sum tax).

\frac{\Delta Y}{\Delta Ip} \frac{\Delta Y}{\Delta G} \frac{\Delta Y}{\Delta G} \frac{1}{1-b}

What is the multiplier effect for Aggregate Expenditure Model?

Given change in the inputs in the Aggregate Expenditure Model, it reflects the impact on the output

What is Version 2 of the Aggregate Expenditure Model at equilibrium given proportional tax?

Y=\frac{1}{1-b+b^{\tau}}\cdot a+Ip+G

What is the 3rd Version of the Aggregate Expenditure Model (Keynesian Cross) 

AE=C+Ip+G+NX

What is the equation for the Keynesian Cross at equilibrium? (lump sum tax)

\frac{1}{1-b}\cdot a+Ip+G+NX-bT

What is the equation for the Keynesian Cross at equilibrium? (proportional tax)

Y=\frac{1}{1-b+b^{\tau}}\cdot a+Ip+G+NX $$

What happens to all the categories of Aggregate Expenditure (C, Ip, G, NX) as interest rate ( r ) increases or decreases?

When r increases, all the categories decrease. When r decreases, all the categories increase.

What is the IS-MP Model?

It is used to analyze links between spending, interest rates, financial markets, and output that shape business cycles.

What is the IS Curve?

The Investment and Spending Curve. It connects how a change in interest rates impacts the AE mode and thus changing the output gap

What is the MP Curve?

The Monetary Policy Curve. Determines short term interest rates.

How are short term interest rates calculated?

Risk Free Interest Rate + Risk Premium

What is the Risk Free Interest Rate?

Rate from Federal Funds Market. Set by the Fed through monetary policy. 

What is a risk premium?

Extra interest that lenders charge to account for the risk of losing money

What are IS Curve Shifters examples under Consumption?

Wealth, Consumer Confidence, Government Assistance, Taxes, Inequality

What are IS Curve Shifters examples under Investment?

GDP growth, Business confidence, investment tax credits, corporate taxes, easier lending standards and cash reserves, uncertainty (about the whole economy)

What are IS Curve Shifters examples under Government Purchases?

Spending bills, automatic stabilizers

What are IS Curve Shifters examples under Net Exports?

Global GDP growth, value of US dollar, trade barriers in foreign markets, trade barriers to US market

What are MP Curve Shifters examples under The risk-free rate?

changes in the risk-free rate, expected future interest rates

What are MP Curve Shifters examples under the risk premium?

default risk, liquidity risk, interest rate, risk aversion