Economics 2, lecture 5 - the market for goods and services

What is the aggregate supply (AS) curve? What does happens in the short run, medium run and long run?

Describes the relationship between economic activity and the general process level in the economy.

Short run: fixed prices, fixed technology and fixed capital stock

Medium run: prices change, but tech and capital stock stay the same

Long run: The capital stock and the tech are no longer given, and their growth determine the evolution of potential GDP

What explains the horizontal AS curve?

Output demand are solely explained by changes in aggregate demand, which means that we implicitly assume that factors of production are underemployed

What is the modern theory of consumption?

The modern theory of consumption seeks to explain consumer behavior and spending patterns, emphasizing factors such as expectations of future income, wealth, and the role of social influences on consumption decisions.

How is an agents discounted wealth calculated? 3

1. The wealth he has accumulated up to now (financial and real astate assets)

2. His current disposable income Y_D

3. The present value of his future (anticipated) income Y^e^

—> an individual feels richer when at least one of these increases

What is consumption smoothing?

Consumption smoothing is the practice of consumers optimizing their spending over time to maintain a stable living standard, regardless of fluctuations in income.

What is intertemporal smoothing?

Intertemporal smoothing refers to the strategy of individuals balancing their consumption over time, smoothing out fluctuations in income by adjusting their spending in relation to anticipated future income.

What is meant by role of expectations?

C (households private consumption) may vary even though the agents current income has not been modified

What are the two possible explanations?

1. The existence of credit market imperfections

2. The presence of uncertainty (risk aversion)

What is meant by quantitative restriction on indebtedness?

Impossibility for certain agents to take on debt beyond a certain amount (possibly 0) at the prevailing interest rate

What is meant by a liquidity constrained household?

A household which would have liked to take on (more) debt but was unable to

What is autonomous consumption?

The part of consumption that does not depend on the household’s level of disposable income

What is meant by autonomous net taxes?

Part of the net taxes that do not change as a function of income

What is meant by that our short run modelling of the goods market postulates underutilisation of the production factors? 2

• firms are ready to satisfy any increase in the demand for goods and services without any modification of the aggregate price level

• There excises a pool of currently unemployed workers that are ready to work at the current wage

What are endogenous variables?

Variables whose value are determined within the model

What are exogenous variables?

Variables whose value is imposed and not determined by the model

What is meant by parameters?

Coefficients describing a behavioural or institutional relationship