Principles of Macroeconomics - Chapter 15: Household and Firm Behavior in the Macroeconomy

Flashcards covering household consumption, labor supply decisions, firm investment, and macroeconomic relationships such as Okun's Law and the accelerator effect.

Life-cycle theory of consumption

A theory of household consumption where households make lifetime consumption decisions based on their expectations of lifetime income.

Permanent income

The average level of a person’s expected future income stream.

Substitution effect of a wage rate increase

A phenomenon where a higher wage leads to a larger quantity of labor supplied.

Income effect of a wage rate increase

A phenomenon where people with higher income spend some of it on leisure by working less, because leisure is a normal good.

Nominal wage rate

The wage rate in current dollars.

Real wage rate

The amount the nominal wage rate can buy in terms of goods and services.

Nonlabor (nonwage) income

Any income received from sources other than working, such as inheritances, interest, dividends, and transfer payments.

Substitution effect of an interest rate increase

A rise in the interest rate that leads a household to consume less today and save more.

Income effect of an interest rate fall

A situation where a household with positive wealth experience a fall in interest income due to a decrease in the interest rate.

Transfer payments

Payments such as Social Security benefits, veterans’ benefits, and welfare benefits.

Unconstrained supply of labor

The amount a household would like to work within a given period at the current wage rate if it could find the work.

Constrained supply of labor

The amount a household actually works in a given period at the current wage rate.

Animal spirits of entrepreneurs

A term coined by Keynes to describe investors’ feelings.

Accelerator effect

The tendency for investment to increase when aggregate output increases and to decrease when aggregate output decreases, accelerating the growth or decline of output.

Excess labor and excess capital

Labor and capital that are not needed to produce the firm’s current level of output.

Adjustment costs

The costs that a firm incurs when it changes its production level, such as the administration costs of laying off employees or the training costs of hiring new workers.

Inventory investment

The change in the stock of inventories, calculated as production minus sales.

Desired (optimal) level of inventories

The level of inventory at which the extra cost in lost sales from lowering inventories by a small amount is just equal to the extra gain in interest revenue and decreased storage costs.

Productivity (Labor productivity)

Output per worker hour.

Okun’s Law

The theory that in the short run the unemployment rate decreases about $1$ percentage point for every $3\%$ increase in real GDP.

Discouraged-worker effect

The decline in the measured unemployment rate that results when people who want to work but cannot find work grow discouraged and stop looking, dropping out of the labor force.

Inventory-to-sales ratio

The ratio of the firm sector’s stock of inventories to the level of sales.

Procyclical productivity

The tendency for measured productivity (the output-to-labor ratio) to rise during expansionary periods and decline during contractionary periods.