Lecture 5

What is the consumption function?

The consumption function describes how consumption depends on disposable income: C=C(Y−T).

What is the investment function?

The investment function describes how investment depends on the interest rate: I=I(r).

What is the difference between nominal and real interest rates?

The nominal interest rate is the stated rate, while the real interest rate adjusts for inflation: r=i−π.

What is the role of financial markets in the economy?

Financial markets balance savings and investment, determining the equilibrium interest rate.

What happens to investment when government spending increases?

Investment decreases due to the crowding-out effect, as higher government spending raises interest rates.

The __________ describes how consumption depends on disposable income.

consumption function

The __________ describes how investment depends on the interest rate.

investment function

The __________ adjusts the nominal interest rate for inflation.

real interest rate

Financial markets balance __________ and __________, determining the equilibrium interest rate.

savings and investment

Increased government spending leads to __________, which reduces private investment.

higher interest rates