Chapter 4 - Economics Midterm 2 Review Chapter 4: Goods...

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Economics Midterm 2 Review Chapter 4: Goods Market Consumption and Saving Changes in consumer’s willingness to spend have major implications on the behaviour of the economy this is b/c consumption spending by households is the largest component of the demand for G/S The decision how much to consume is closely linked to another important economic decision, the decision to save i.e if you decide to buy something, whatever you don’t spend, you save national level of desired consumption: the aggregate quantity of G/S that households want to consume, given income and other factors that determine household’s economic opportunities desired national saving: is the level of national saving that occurs when aggregate consumption is at its desired level Effects of changes in Current Income Current income is an important factor affecting consumption and saving decisions The amount of bonus someone is willing to spend depends on their willingness to defer gratification and their assessment of their current and future needs Marginal propensity to consume: the fraction of additional current income that someone consumes in the current period When consuming some but not all of the extra income, MPC will be between zero and one MPC, also applies when someone’s income decreases An increase in aggregate output (income) Y leads to an increase in aggregate desired consumption, C d Since MPC is < 1, the increase in C d will be less than the increase in Y Effects of changes in expected future income Today’s consumption decisions also depends on the income that one expects to earn in the future
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Ex: someone who is currently unemployed, but has signed a contract for a high paying job, will more likely consume more today than another unemployed individual with no job prospects An increase in an individual’s expected future income is likely to lead that person to increase current consumption and decrease current saving Therefore, if people expect that aggregate output and income, Y will be higher in the future, C d should increase and S d should decrease Effects of Changes in Wealth Wealth = assets – liabilities An increase in wealth increases current consumption and reduces current saving Most common forms of wealth are stocks and housing Effects of Changes in the Real Interest Rate Real interest rate is the price of current consumption in terms of future consumption An increase in r, increases S d b/c you get more in the future by saving more now On the other hand, you need to save less now to have the same amount in the future, so an increase in r can also decrease S d The two opposing effects are known as the substitution effect and the income effect of an increase in the real interest rate Substitution effect of the real interest rate on saving reflects the tendency
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This note was uploaded on 01/09/2011 for the course ECON 202 taught by Professor Angelatrimarchi during the Spring '10 term at Waterloo.

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Chapter 4 - Economics Midterm 2 Review Chapter 4: Goods...

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