ECON 104Fall 2016REVIEW FOR EXAM 3Key Terms and ConceptsNote: Text pages refer to Hubbard & O’Brien, 5thedition. If you have the 4thedition, I have a copy of the 4thand the 5thand so does Pattee Library if you want to determine the corresponding pages in the 4th. Chapter 12: AE & Output in the Short Run, packet pages 105 - 128; text pages 372 - 3871.The Great Depression; Classical Theory; Keynesian Theorya.The Great Depression 1929 - 1938i.stock market crashed: stock prices fell1.HH wealth plummeted or disappearedii.expected future income (cc) felliii.real GDP fell 30%iv.Unemployment rose to 25%v.businesses closedvi.banks failed by the thousands (no FDIC)b.Classical Theory (Adam Smith) prior to GDi.based on microeconomic theoryii.Laissez-Faire: Economy would correct itself; recessions are only temporaryc.Keynesian Theory, 1936i.economy was not self correctingii.if total spending is inadequate, the economy will not reach full employment on its owniii.policy makers should step in to help restore full employment (increase G, cut T)iv.AE Model: C + I + G + NX = AD modeld.John Maynard Keynes: A Theory of Consumptioni.Yd = C + Sii.C = a + b (Yd) The C Functioniii.where: Yd = (Y – Taxes + Transfers) = disposable income2.Consumption (C) function, MPC and MPSa.C functioni.relationship between consumption spending and disposable incomeii.C = a + b (Yd) The C Functioniii.changes in consumption depend on changes in disposable income, so consumption is afunction of disposable incomeb.MPC, Marginal propensity to consumei.the slope of the C function: the amount by which consumption spending changes whendisposable income changes (equals b in the C function) (0 < b < 1)ii.MPC = change in C / change in Ydiii.change in C = change in Yd x MPCc.MPS, Marginal propensity to savei.the amount by which savings changes when disposable income changesii.MPS = change in S / change in Yd
d.Income, consumption, and savingi.Y = C + S + T → ∆Y = ∆ C + ∆S (∆ T is constant so it = 0)1.Y represents national income (and GDP)ii.when equation is divided by change in income (Y) you see that 1 = MPC + MPS1.because part of any increase in income is consumed and whatever remains is saved 3.Autonomous consumption; disposable income (Yd) = ______________; wealth a.Autonomous consumptioni.intercept, autonomous consumption (nothing to do with income/ does not depend on Yd) (represents a in C function)b.Disposable Incomei.disposable income = National income – Net taxesii.National Income = GDP = Disposable income + Net taxesc.Wealthi.W = Assets – Liabilities4.Saving (S) = 5.Factors that affect the C functiona.move along C function:i.∆ disposable incomeii.∆ taxesb.shift the C function (change in the intercept, change in a)i.∆ HH wealth: Wii.∆ expected future income: Ye (consumer confidence)iii.∆the price level: Piv.∆ the real interest rate: rc.C = f (+Yd, –T, +Wealth, +Ye, –P, –r)i.+ when variable increases, C increasesii.– when variable increases, C decreases6.Theory of Investment and investment demand
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