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Chapter 12

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1/24

Terms in this set (24)

  • What determines the level of GDP in any particular year according to the Aggregate Expenditure Model?
    The level of GDP is determined by the level of total spending (aggregate expenditure).
  • What causes changes in real GDP and employment in the short run?
    Changes in total spending cause changes in real GDP and employment in the short run.
  • What happens if total spending is less than total production (real GDP)?
    Inventories increase, leading to a decrease in total production and employment.
  • What happens if total spending is greater than total production (real GDP)?
    Inventories decrease, leading to an increase in total production and employment.
  • What assumptions does the Aggregate Expenditure (AE) model make about potential GDP and prices?
    The AE model assumes potential GDP is fixed and prices are fixed.
  • What type of unemployment does the AE model explain?
    The AE model explains cyclical unemployment related to short-run business cycle fluctuations.
  • What is macroeconomic equilibrium in the AE model?
    It occurs where planned aggregate expenditure (AE) equals total production (real GDP).
  • What signals whether firms should increase or decrease production and employment?
    Unintended inventories, calculated as real GDP minus aggregate expenditure, signal production adjustments.
  • List the four factors that determine consumption spending (C).
    Current disposable income (+), household wealth (+), expected future income (+), and interest rate (-).
  • How does the interest rate affect consumption spending?
    Higher interest rates increase saving, decrease consumption, and raise borrowing costs for durable goods.
  • What are the three factors that determine investment spending (I)?
    Expectations of future profitability (+), interest rate (-), and business taxes (-).
  • How do business taxes affect investment spending?
    A reduction in corporate income tax increases after-tax profitability, increasing investment spending.
  • What determines net exports (NX)?
    Growth rate of foreign real GDP (+) and the exchange rate between the dollar and other currencies (-).
  • How does an increase in foreign real GDP affect U.S. net exports?
    It increases foreign demand for U.S. exports, raising net exports.
  • What is the effect of an appreciation of the dollar on net exports?
    An appreciation raises the cost of U.S. exports and lowers the cost of imports, decreasing net exports.
  • Where does macroeconomic equilibrium occur graphically in the AE model?
    At the intersection of the planned aggregate expenditure (AE) line and the 45° line where AE = real GDP.
  • What shifts the AE line and changes equilibrium real GDP?
    Changes in autonomous expenditure (variables other than current income affecting C, I, G, or NX).
  • What is the multiplier effect in macroeconomics?
    The process by which a change in autonomous expenditure leads to a larger change in real GDP.
  • Write the formula for the multiplier.
    Multiplier = \(\frac{1}{1-MPC}\), where MPC is the marginal propensity to consume.
  • How does the marginal propensity to consume (MPC) affect the multiplier?
    The larger the MPC, the larger the multiplier and the greater the change in real GDP from autonomous spending.
  • What happens to real GDP if net exports rise by \$100 billion and MPC = 0.8?
    Real GDP increases by \$500 billion, calculated as \(100 billion × \(\frac{1}{1-0.8}\) = \)500 billion.
  • Why can a decline in spending on residential construction cause widespread recession effects?
    Because of the multiplier effect, initial spending declines reduce income and consumption broadly, affecting many industries.
  • What does 'inventory drawdown' mean and how does it affect GDP?
    Inventory drawdown is a reduction in inventories, signaling firms to reduce production, which contributes to GDP decline.
  • How do planned and unplanned inventory changes affect the business cycle?
    Planned inventory increases reflect expected demand, while unplanned changes signal production adjustments affecting GDP.