Macroeconomics: Consumption, Investment, and Aggregate Demand

This set of flashcards covers key concepts from macroeconomics, focusing on consumption, investment, aggregate demand, exchange rates, and the economic adjustments related to recessionary and inflationary gaps.

What is consumption in macroeconomics?

Consumption refers to household spending on goods and services and is the largest component of GDP.

What does the equation Y = C + I + G + NX represent?

It represents the components of Gross Domestic Product (GDP): C = Consumption, I = Investment, G = Government spending, NX = Net Exports.

How does disposable income affect consumption?

An increase in disposable income leads to an increase in consumption.

What does the consumption function represent?

It shows the linear relationship between consumption and disposable income: C = a + MPC × Yd, where 'a' is autonomous consumption and MPC is the marginal propensity to consume.

What is the formula for marginal propensity to consume (MPC)?

MPC is calculated as MPC = ΔC / ΔYd, where ΔC is the change in consumption and ΔYd is the change in disposable income.

What is investment in macroeconomic terms?

In macroeconomics, investment refers specifically to spending that creates new productive capacity.

What are examples of business fixed investment?

Factories, machines, equipment, technology such as software, robots, and computers.

What happens to inventories when firms produce more than they sell?

Inventories rise, which is considered an addition to investment.

What effect does an increase in real interest rate have on investment?

Higher real interest rates generally decrease investment due to increased borrowing costs.

What are net exports (NX) defined as?

Net exports are calculated as exports (X) minus imports (IM).

What factors affect net exports?

Domestic income, foreign income, exchange rates, domestic preferences for foreign goods, foreign preferences for U.S. goods, and trade policies influence net exports.

What is the effect of a stronger dollar on net exports?

A stronger dollar makes U.S. goods more expensive to foreigners, reducing exports and increasing imports, leading to a decreased NX.

What is the real exchange rate (e) and why is it important?

The real exchange rate measures a country's competitiveness and is defined by the formula e = (E × Pdom) / Pfor.

How does aggregate demand (AD) shift in response to an increase in net exports?

If net exports increase, aggregate demand shifts to the right.

What is the difference between aggregate demand (AD) and aggregate expenditure (AE)?

AD shows total demand at various price levels, while AE is total planned spending at a fixed price level.

Why does the AD curve slope downwards?

The AD curve slopes downwards due to the wealth effect, interest rate effect, and international trade effect.

What causes a shift to the left on the AD curve?

A decrease in consumer confidence or higher interest rates can lead to a leftward shift in the AD curve.

What is long-run aggregate supply (LRAS) and its relationship to the economy?

LRAS is vertical at potential GDP and reflects the economy's maximum sustainable output, independent of price levels.

What defines a recessionary gap in macroeconomics?

A recessionary gap occurs when actual output is below potential output, resulting in higher unemployment and lower price levels.

How does the economy correct from a recessionary gap?

Wages decrease due to high unemployment, which decreases costs for firms and shifts the SRAS right until equilibrium is restored.

What is an inflationary gap?

An inflationary gap occurs when actual output exceeds potential output, leading to lower unemployment and rising price levels.

What is the adjustment mechanism for an inflationary gap?

Wages increase to attract labor due to high demand, which raises production costs and shifts SRAS left until equilibrium is achieved.