Econ Exam 3

Expenditure approach

who does the purchasing; focused on the value of total output

Gross Private Domestic Investment (I)

business spending plus consumer spending on
new residential housing; does NOT refer to the purchase of stocks and bonds

Fixed investment

business spending on land, buildings, machinery, and equipment
(capital or durable goods)

Inventory investment

raw materials, goods in process, and finished goods on hand

Depreciation

reduction in the value of capital goods due to wear and tear

*Net investment (NI)

gross private domestic investment – depreciation (Positive net investment means the productive capacity is expanding)

Net Domestic Product (NDP)

GDP - depreciation; measures future productive capacity

Personal income (PI)

income households receive before they pay income taxes

*Disposable personal income (DPI)

can be spent or saved

Real GDP

value of final output that is adjusted for price level changes; used to compare GDP from one year to another to determine economic growth

Factors that contribute to economic growth:

• Increase in the labor force
o Immigration policy
• Higher labor productivity
o Investment in human capital (education and training)
• New technology and innovation
o Encourage research and design
o Protection of property rights (physical and intellectual property)
• Higher savings rate (funds investment)

Per capita real GDP

Reflects the standard of living for a country
(real GDP ÷ total population)

The long run (LR) assumes:

• wages and prices are free to change
• the economy always self-adjusts to equilibrium at full employment
• the economy is on its PPC

Long-run aggregate supply (LRAS) curve

a vertical line representing the real output of
goods and services; represents real GDP at full employment

Slope of the aggregate demand curve

it is downward right because as price level decreases people buy more

Factors that shift the AD

the ability to produce can increase due to additional resources and improved technology. If that happens, the PPC shifts outward and the LRAS curve shifts to the right.

Long run equilibrium occurs where

where the AD curve and the LRAS curve intersect

Historical causes of inflation

occur because of a leftward shift in LRAS or a rightward shift in AD (not representing full employment

Assumptions of the Classical Model

• Wages, prices and interest rates are flexible so there are no shortages or surpluses.
• Economic problems are temporary; government intervention is not needed (laissez-faire).
• The economy self-adjusts to equilibrium at the natural rate of unemployment

Unemployment equals

the natural unemployment rate (only structural and frictional
exist)

Wages, prices and interest rates adjust

quickly; the economy is always on the LRAS curve

Equilibrium can occur

at an undesirable rate of output

The Keynesian short run aggregate supply curve is

Horizontal

Additional factors of production or technology improvements

AS shifts rightward

A decline in factors of production or technology

AS shifts leftward

Recessionary gap

exists when equilibrium
real GDP is less than full employment real GDP
based on the LRAS curve.

Inflationary gap

exists when equilibrium real
GDP is greater than full employment real GDP
based on the LRAS curve.
• Increase in AD: real GDP and price level
• In this case, the inflationary gap equals $22.2
trillion minus $22 trillion or $200 billion.

Cost-push inflation

inflation caused by decreases in short-run aggregate supply

disposable income is

the primary determinant of consumption and saving

Consumption function

the relationship between amount consumed and disposable
income; how much people consume at various levels of disposable income

Autonomous consumption (a)

consumption that occurs independent of income;
level of consumption that occurs when income is zero; changes in autonomous
consumption shift the consumption function up and down in a graph

Marginal propensity to consume or MPC (b)

the change in consumption divided by
the change in disposable income; the fraction of each additional dollar of income
spent on consumption

Average propensity to consume or APC

consumption divided by disposable income;
the percentage of income that is consumed

Average propensity to save or APS

saving divided by disposable income; the
percentage of income that is saved

relationship between the interest rate and the level of investment

There is an inverse relationship between the
interest rate and the level of investment; the
investment curve slopes downward to the
right.

The initial investment spending

was
multiplied through the economy resulting in
a much larger change to equilibrium real GDP.