# Chapter 7-9 - CHAPTER 7 1 Forces that push the economy off...

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CHAPTER 7: 1. Forces that push the economy off its growth path a. Aggregate Demand Curve: i. In the short-run demand determines output; firms privide a level of output their customers demand at existing prices ii. The aggregate demand curve shows the level of output corresponding to alternative price levels, including the existing price level iii. ANy event that shifts the AD curve pushed the econmy away from potential. Fiscal and Monetary poloicy, consumption, investment anf foreign purchases can all shift the AD curve 2. Aggregate demand and the spending decision a. Aggregate demand theory starts by examining peoples decision to buy goods, or their spending decisions. 3. The Unresponsiveness of te price level: a. When an increase in demand results in a firm producing at above-average operating levels, it usually increases its prices as well 4. The point of balance of income and spending a. Spending Balance: occurs when the level of income used by consumers and other spendrs in making their spending decisions is the same as the sum of the spending of all spenders b. The income identitiy: Y=C+I+G+X c. The consumption funciton: a description of the total consumption demand of all families in the economy. i. The larger the families income, the larger their consumption 1. C= a+bY d a. This algebraic formula says that conumption, C is equal to some constant, a plus another ocnstant, b times disposable income, y. b. Constants are are positive and b is less than 1. i. B is the marginal prospensity to consume ii. Marginal prospensity to consume: measures how much of an additional dollar of disposable income is spoent on consumption iii. A is the intercept of the consumption function 1. These coefficients work together to describe the relationship between income and consumption c. What is consumption function i. Disposable income is the amount of income people have to spend after taxes ii. The consumption function says that there is a predictable relationship between disposable income and conumption iii. The margin prospensity to consume is the

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fractionof an increase in disposale income tht is consumed d. Consumption function written as income isntead of disposable income: i. C= a+ b(1-t)Y 1. THis states that consumption depends positively on income ii. Investment, Government spending, and net exports are exogenous iii. Consumption and income are enogenous variables iv. Spending balance: 1. Intersects two lines the spending line and 45 degree line a. Spending line shows how total spending depends on income i. Total spending is sum of consumption, investment, government spending and ii. Spending line equation: iii. spending= a+b(1-t)Y+I+G+X 2. Spending balance: a. Simple model of income determination consists of two relationships, the consumption function and the income identity b. SPending balance occurs when consumers choose their consumption levels, C, on the basis of a level of income that is the same as the level GDP c. In terms of the equations, spending balance occurs at levels of consumption C and income Y that
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