CH 21 - The Simplest Short-Run Macro Model

# CH 21 - The Simplest Short-Run Macro Model - CHAPTER 21 THE...

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CHAPTER 21 THE SIMPLEST SHORT-RUN MACRO MODEL 21.1 DESIRED AGGREGATE EXPENDITURE Desired aggregate expenditure (AE) = the amount that economic agents want to depend on purchasing the national product AE = C + I + C + [X - IM] National income accounts measured actual expenditures in each of the 4 expenditure categories. National income theory deal with desired expenditures in each of these 4 categories DESIRED CONSUMPTION EXPENDITURE: By definition, there are only 2 possible uses of disposable income o Consumption o Saving When the household decides how much to put to one use, it has automatically decided how much to put to the other use Consumption Function o Constant term = autonomous expenditure o Part of consumption that responds to income is called induced expenditure o Holding constant other determinants of desired consumption, an increase in income is assumed to lead to an increase in desired consumption o APConsume = C/Y D o MPConsume = ∆C/∆Y D aka slope of consumption function C = desired consumption Y D = value of disposable income o 45 o Line Saving Function : o APSave = S/Y D o MPSave = ∆S/∆Y D aka slope of consumption function S = desired saving Y D = value of disposable income A change in disposable income leads to a change in desired consumption + desired saving. o The responsiveness of these changes is measured by the marginal propensity to consume (MPC) and the marginal propensity to save (MPS) o APC + APS = 1 all disposable income either consumed or saved Shifts in the Consumption Function: o Changes in wealth, interest rates or expectations about the future lead to changes in autonomous consumption = consumption function shifts o Changes in Wealth = directly related Increase in wealth = shifts the consumption function up

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## This note was uploaded on 04/18/2008 for the course ECON 295 taught by Professor Ragan during the Spring '08 term at McGill.

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CH 21 - The Simplest Short-Run Macro Model - CHAPTER 21 THE...

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