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Module 16-17

Multiplier

When there is an increase in the CIGXn, it is going to have a multiplying effect on the economy.

One person's income becomes another individual's income and on and on.

Thus, money in an economy is spent multiple times. It acts as a chain reaction that will increase GDP greater than the initial change in spending.

Disposable Income

All money left over after all taxes are deducted.

MPC - Marginal Propensity to Consume

Increase in consumer spending when disposable income rises by one dollar.

MPC = Change in consumer spending / change in disposable income.

MPS - Marginal Propensity to Save

MPC + MPS = one dollar.

Multiplier

1/(1-MPC) or 1/MPS

Consumption Function <- Test Question

What does the consumption show?

It shows the relationship between disposable income and consumer spending. If your disposable income increases, your consumers spending will then increase as well.

What will shift the consumption function?

  • Changes in wealth.
    • Wealth is a person's net worth.
      • Assets - Liabilities
  • Change in expectations about future income.

Aggregate Demand

Shifters of the demand curve: EWC$

  • Anything that increases GDP - CIGXn
  • E - Changes in expectations.
  • W - Changes in wealth.
  • C - Size of capital stock.
  • $ - Fiscal policy and monetary policy.
    • When the government uses expansionary either, it will shift towards the right.
    • When the government uses contractionary either, it will shift towards the left.
    • Fiscal Policy - When congress speeds up or slows the economy by either manipulated taxes or manipulating government transfers or purchases.
    • Monetary Policy - Increasing or decreasing interest rates.

When the aggregate supply curve shifts towards the left, the price level rises in the economy, and output in the economy will decrease.

Recessionary and inflationary gaps caused by aggregated demand shocks are fixable using fiscal and monetary policies.

Negative demand shocks = high unemployment

Positive demand shocks = inflation

Negative supply shock = stagflation

Positive supply shock = lowers prices and lowers unemployment 

Change in rGDP

Multiplier * change in spending.

Usually government or investment spending.

Stagflation

When there is both greater inflation and higher unemployment.

Negative supply shocks that cause inflation and higher unemployment are not fixable using fiscal and monetary policies.

In the long run, the economy will ultimately self-correct.

Our government will intervene to fix the problem with the economy sooner than if the economy will self-correct.

John Maynard Keynes

Solution to recession: Deficit spending.

That if the economy is in a recession, use the government to actively assist the economy out of a recession.

i.e. let the government spend as much money as it wants.

When the government spends the money that it does not have to fix the economy. They borrow the money in order to do so.

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