MACRO YUHSavings–Investment Spending Identity (Closed Economy); In a closed economy, total savings (S) always equals investment spending (I). Savings–Investment Spending Identity (Open Economy); In an open economy, investment = national savings + net capi

Savings-Investment Spending Identity (Closed Economy)

In a closed economy, total savings (S) always equals investment spending (I).

Savings-Investment Spending Identity (Open Economy)

In an open economy, investment = national savings + net capital inflow (I = S + NCI).

Net Capital Inflow (NCI)

The total inflow of foreign funds into a country minus the total outflow of domestic funds to other countries (NCI = IM - X).

Private Savings

Disposable income minus consumption and taxes; savings by households.

Government Savings

The difference between tax revenue and government spending (T - TR - G).

Budget Surplus

When tax revenue exceeds government spending.

Budget Deficit

When government spending exceeds tax revenue.

National Savings

The sum of private and government savings; total savings within an economy.

Government Borrowing

The amount of funds the government borrows in financial markets to cover budget deficits.

Loanable Funds Market

A model that shows how savers are matched with borrowers through interest rates.

Interest Rate

The price paid for borrowing funds, expressed as a percentage of the loan amount.

Nominal Interest Rate

The interest rate unadjusted for inflation.

Real Interest Rate

The nominal interest rate minus the inflation rate; represents the true cost of borrowing.

Demand for Loanable Funds

Downward sloping because lower interest rates make borrowing cheaper and encourage investment.

Supply of Loanable Funds

Upward sloping because higher interest rates reward saving.

Equilibrium Interest Rate (r)

* The rate at which the quantity of loanable funds supplied equals the quantity demanded.

Present Value

The amount of money needed today to receive a future sum given a specific interest rate (PV = FV / (1 + r)).

Crowding Out

When government borrowing raises interest rates and reduces private investment spending.

National Savings Equation (Open Economy)

I = S + NCI, where investment equals national savings plus net capital inflow.

Fisher Effect

An increase in expected inflation raises nominal interest rates, leaving real rates unchanged.

Financial Asset

A paper claim entitling the buyer to future income from the seller (e.g., loans, bonds, stocks).

Liability

A financial obligation to pay income in the future; the counterpart to a financial asset.

Physical Asset

A tangible object like a house or machine that can generate future income.

Three Tasks of a Financial System

Reducing transaction costs, reducing risk, and providing liquidity.

Transaction Costs

Expenses incurred in making a financial deal.

Risk Aversion

The desire to avoid uncertainty or risk in financial decisions.

Diversification

Investing in several assets to reduce exposure to risk.

Liquidity

The ease with which an asset can be converted into cash without significant loss in value.

Loans

Lending agreements between individual lenders and borrowers, often with high transaction costs.

Bonds

IOUs issued by borrowers that promise fixed interest payments and repayment at a specific time.

Default Risk

The chance that a borrower fails to make required payments on a bond or loan.

Stocks

Shares of ownership in a company that entitle the owner to part of the company's profits.

Financial Intermediaries

Institutions like banks, mutual funds, and insurance companies that link savers and borrowers.

Bank Deposits

Claims that give the depositor the right to withdraw funds; liabilities for the bank.

Mutual Fund

A financial intermediary that builds a stock portfolio and resells shares to investors.

Multiplier Effect

The process by which an initial change in spending leads to multiple rounds of income and spending increases.

Marginal Propensity to Consume (MPC)

The fraction of additional disposable income that is spent on consumption (ΔC/ΔYd).

Marginal Propensity to Save (MPS)

The fraction of additional disposable income that is saved (1 - MPC).

Multiplier Formula

1 / (1 - MPC); the total change in GDP from an initial change in spending.

Autonomous Change in Aggregate Spending

An initial, independent change in spending that causes further changes in GDP.

Autonomous Consumer Spending

Spending that occurs even with zero income; the intercept of the consumption function.

Disposable Income (Yd)

Income after taxes and government transfers are taken into account.

Consumption Function

The relationship between consumption and disposable income (C = a + MPC × Yd).

Aggregate Consumption Function

The relationship between total consumption and total disposable income (C = A + MPC × YD).

Life-Cycle Hypothesis

The idea that consumers plan their spending over their lifetime, smoothing consumption.

Permanent Income Hypothesis

The idea that spending depends on long-term expected income, not just current income.

Shifts in Consumption Function

Caused by changes in expected future income or aggregate wealth.

Planned Investment Spending

Investment firms intend to undertake based on interest rates, expected GDP, and capacity.

Unplanned Inventory Investment

Changes in inventories due to unexpected sales levels.

Actual Investment Spending

The sum of planned investment and unplanned inventory investment (I = Iplanned + Iunplanned).

Interest Rate and Investment

Lower interest rates make investment more attractive; higher rates reduce it.

Accelerator Principle

Higher GDP growth leads to higher planned investment spending, and vice versa.

Income-Expenditure Model

A model showing how changes in spending lead to equilibrium GDP.

Planned Aggregate Expenditure (AEplanned)

Total planned spending in the economy (AEplanned = C + Iplanned).

Income-Expenditure Equilibrium

Occurs when AEplanned equals real GDP (no unplanned inventory changes).

Unplanned Inventory Increase

When GDP > AEplanned, leading to extra inventories and reduced production.

Unplanned Inventory Decrease

When GDP < AEplanned, leading to lower inventories and increased production.

Equilibrium GDP

The level of GDP where planned spending equals actual output.

Leading Indicator

Economic factors like investment spending that predict future economic activity.

Aggregate Demand (AD)

The relationship between the aggregate price level and total quantity of goods and services demanded (C + I + G + X - IM).

Wealth Effect

Higher price levels reduce the real value of wealth, decreasing consumer spending.

Interest Rate Effect

Higher prices increase interest rates, reducing investment and consumption.

Downward Slope of AD Curve

Due to the wealth and interest rate effects.

Factors that Shift AD Right

Higher optimism, higher wealth, higher government spending, lower taxes, and monetary expansion.

Factors that Shift AD Left

Lower confidence, lower wealth, reduced government spending, and monetary contraction.

Fiscal Policy

Government decisions about spending and taxes to influence the economy.

Monetary Policy

Central bank decisions about money supply and interest rates.

Aggregate Supply (AS)

The relationship between the aggregate price level and total quantity of output supplied.

Short-Run Aggregate Supply (SRAS)

Upward sloping due to sticky wages; higher prices increase profits and output.

Sticky Wages

Nominal wages slow to adjust to changes in economic conditions.

Long-Run Aggregate Supply (LRAS)

Vertical line at potential output (Yp) where prices and wages are flexible.

Potential Output (Yp)

The level of GDP produced when the economy is at full employment.

Shifts in SRAS

Left if input costs or wages rise; right if productivity improves or input prices fall.

Shifts in LRAS

Caused by long-term changes in resources, labor, and technology.

Recessionary Gap

Actual output below potential output, creating unemployment pressure.

Inflationary Gap

Actual output above potential output, creating inflation pressure.

Output Gap Formula

(Actual GDP - Potential GDP) / Potential GDP × 100.

Short-Run Equilibrium

Where AD intersects SRAS; determines short-run output and price level.

Long-Run Equilibrium

Where AD, SRAS, and LRAS intersect.

Demand Shock

An event that shifts AD, changing output and prices in the same direction.

Supply Shock

An event that shifts SRAS, changing output and prices in opposite directions.

Positive Supply Shock

Increases output and lowers price levels.

Negative Supply Shock

Reduces output and increases price levels (stagflation).

Stagflation

Combination of high inflation and low output due to a negative supply shock.

Self-Correction

The process by which wages and prices adjust to restore long-run equilibrium.

Sticky Wage Theory and Great Recession

Wages failed to fall quickly, prolonging unemployment during the 2008-2009 crisis.

Policy Stabilization

The use of fiscal and monetary policies to counteract demand shocks and stabilize output.