ECO 202 Exam 2 Study Guide: Aggregate Expenditure and Demand

Aggregate Expenditure

The total amount of spending in an economy, including consumption, planned investment, government purchases, and net exports.

Actual Investment

The sum of business fixed investment, residential investment, and unplanned changes in business inventories.

Planned Investment

The actual investment minus the change in business inventories.

Macroeconomic Equilibrium

A state where the change in inventories equals zero.

Consumption

The total spending by households on goods and services.

Current Disposable Income

Personal income minus personal income taxes plus transfer payments.

Household Wealth

The difference between total assets and total liabilities.

Expected Future Income

The anticipated income that influences current consumption levels.

Price Level

The average level of prices in the economy, which affects real wealth and consumption.

Interest Rate

The cost of borrowing money, which influences consumption and investment spending.

Consumption Function

The relationship between consumption and disposable income, often represented as a linear function.

Autonomous Consumption

The level of consumption that occurs even when income is zero.

Marginal Propensity to Consume

The change in consumption resulting from a change in disposable income.

Planned Investment Determinants

Factors that influence planned investment, including expected profits, interest rates, taxes, and cash flow.

Government Purchases

Expenditures by the government that have increased over time, even during recessions.

Net Exports

The difference between exports and imports, which has been negative for the U.S. in recent decades.

Multiplier Effect

The phenomenon where an increase in autonomous expenditures leads to a more than proportional increase in GDP.

Unplanned Investment

Investment that occurs when actual sales differ from expected sales, leading to changes in inventory levels.

Positive Unplanned Investment

Indicates that aggregate expenditure is less than GDP, suggesting that GDP will eventually decrease.

Income and Consumption Data

Data showing the relationship between income and consumption over different years.

Unplanned Decrease in Inventories

Indicates that aggregate expenditure is higher than GDP, suggesting that production will increase.

Marginal Propensity to Consume in PopTart Nation

Calculated based on the increase in real GDP resulting from an increase in net exports.

Aggregate Demand Curve

Relationship between price level and real GDP demanded.

Wealth Effect

Higher prices reduce household wealth, decreasing consumption.

Interest Rate Effect

Increased prices raise interest rates, reducing investment.

International Trade Effect

Higher prices decrease exports and increase imports.

Shifts in Aggregate Demand

Changes in factors causing AD curve to move.

Leftward Shift of AD

Caused by higher interest rates or increased taxes.

Rightward Shift of AD

Caused by increased government purchases or optimism.

Aggregate Supply

Quantity of goods/services firms are willing to supply.

Long-Run Aggregate Supply (LRAS)

Real GDP determined by labor, technology, capital stock.

Short-Run Aggregate Supply (SRAS)

Downward sloping curve reflecting short-run price stickiness.

Sticky Prices

Prices slow to adjust in the short run.

Menu Costs

Costs associated with changing prices.

Money

Asset accepted for goods/services or debt payments.

Medium of Exchange

Facilitates transactions between buyers and sellers.

Unit of Account

Standard numerical unit of measurement for value.

Store of Value

Retains value over time for future use.

Fiat Money

Currency authorized by government, not backed by commodity.

M1

Narrow money definition: currency and checking deposits.

M2

Broad money definition: M1 plus savings and time deposits.

Required Reserve Ratio (RRR)

Minimum fraction of deposits banks must keep as reserves.

Simple Deposit Multiplier

Multiplier effect based on required reserves.

Excess Reserves

Reserves held above the legal requirement.

Real World Multiplier

Actual multiplier lower than theoretical due to factors.

Aggregate Expenditure (AE)

Total spending in the economy, includes C, I, G, NX.

Net Exports (NX)

Exports minus imports in an economy.

Short-Run Equilibrium

Temporary balance between AD and SRAS before adjustments.

Money Supply

Total amount of money available in economy.

Federal Reserve (Fed)

Central bank of the United States.

Board of Governors

Main decision-making body of the Fed.

Federal Open Market Committee (FOMC)

Group managing open market operations.

Open Market Operations

Buying/selling Treasury securities to control money supply.

Discount Rate

Interest rate banks pay to borrow from the Fed.

Reserve Requirements

Minimum reserves banks must hold against deposits.

Shadow Banking System

Non-bank financial institutions providing credit.

Investment Banks

Banks that underwrite and trade securities.

Money Market Mutual Funds

Investment funds that invest in short-term debt.

Hedge Funds

Private investment funds using various strategies.

Quantity Theory of Money

Theory linking money supply to price level.

Quantity Equation

M V = P Y, where M is money supply.

Velocity of Money

Rate at which money circulates in economy.

Inflation

Increase in prices and decrease in purchasing power.

Deflation

Decrease in prices and increase in purchasing power.

Real GDP Growth

Increase in economic output adjusted for inflation.

Deposit Multiplier

Factor determining how much money supply can increase.

Hyperinflation

Extremely high and typically accelerating inflation.

Bank Runs

Mass withdrawal of deposits from a bank.

Monetary Policy

Actions by the Fed to control money supply.

Open Market Purchase

Fed buys securities to increase money supply.

Financial Crisis of 2007-2009

Global economic downturn triggered by housing market collapse.

Four big goals of the Fed

Price stability, High employment, Stability of financial markets and institutions, Economic Growth.

Demand For Money

The 'price of money'/opportunity cost of holding money is the interest rate.

Effect of Higher Interest Rates

Higher interest rates result in a lower quantity of money demanded.

Shifts in the Money Demand Curve

Increase in real GDP shifts the money demand curve to the right.

Fed's Control Over Money Supply

In modern times, the Fed uses the money supply to target the interest rate (namely, the Federal funds rate).

Equilibrium Interest Rate

Equilibrium interest rate is determined by the intersection of the money demand curve and the money supply curve.

Assumption of Fed's Targeting

By targeting the federal funds rate (a nominal interest rate), the Fed can affect real interest rates and therefore real GDP.

Decrease in Interest Rates

Increases consumption, Increases investment, Increases Net exports.

Expansionary Monetary Policy

Decreasing interest rates to increase aggregate demand.

Contractionary Monetary Policy

Increasing interest rates to decrease aggregate demand.

Poorly Timed Monetary Policy

May result in economy overheating and causing another recession in extreme cases.

Monetary Growth Rule

Increasing money supply at some constant rate - for example, set it equal to long rate of real GDP growth.

Countercyclical Policy

Trying to fight recessions and/or 'throwing water on an overheating economy'.

Challenges of Monetary Policy

The Fed rarely knows current economic variables - it only knows past values of them.

Great Recession

Notable in that consumption spending actually dropped by a non-trivial amount.

Residential Investment Spending

Dropped considerably - and had been dropping even before the Great recession started.

Causes of the Great Recession

End of the Housing Bubble, the financial crisis, and the 'Shadow Banking system' played a large role.

Bear Stearns

Escaped bankruptcy by being purchased by JPMorgan bank in Spring of 2008.

Lehman Brothers

Declared bankruptcy in Fall of 2008, resulting in tons of money lost.

Rapid Increase in Oil Prices

In response to the recession, Banks started to hold considerable amounts of excess reserves.

Real World Deposit Multiplier

Research has suggested it fell to below 1.

Interest Rate Targeted by the Fed

Federal Funds Rate.

Contractionary Monetary Policy Action

Conduct an open market sale.

Difficulty of Monetary Policy

It takes a very long time to actually increase the money supply.

Negative Supply Shock Response

Central bank must abandon its money supply target and increase the money supply to help return the economy to a long-run equilibrium.

Consumption Spending During Great Recession

Decreased considerably which is in contrast to the idea that people consumption smooth.