Assume firms treat all prices as fixed ignore inflation sometimes called a

# Assume firms treat all prices as fixed ignore

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-Assume firms treat all prices as fixed (ignore inflation): sometimes called a "sticky prices" assumption, assume interest rate r is fixed (so people's savings behavior is fixed and the market for loanable funds is in equilibrium), and there's no gov't (g = 0 and NX =0) -Just focus on consumption -Spending by a consumer= income (for everyone bought stuff from: producers and shareholders) *Each person who gets some new income will consume some of it and save some of it
Y = C + S Spending multiplier- -How much each person consumes depends on their wealth and preferences etc. (some amount of it will be spent. Some could be saved) -Whatever they spend will become further new income to someone else (process repeats: new spending --> new income. At each step less is being spent because some is being saved along the way) -Each dollar is being spent more than once and so each dollar is part of more than one person's income (getting more than the original amount of spending in income) -Autonomous spending: out of the blue spending (can happen for some outside reason). Leads to more than the original amount of new income (a fraction of each dollar gets spent again) Planned investment spending: The investment spending that businesses plan to undertake during a given period -The higher the interest rate, the fewer business projects are productive -Existing production capacity: the richer your economy, the less additional output you need -If firms think there will be more expected future real GDP, will invest more and spend more now -Depends on the interest rate, the expected future level of real GDP, and the current level of production capacity Accelerator principle- A higher rate of growth in real GDP leads to higher planned investment spending -If firms think GDP will grow, they will invest more now to meet that higher demand so GDP grows even faster -If firms think that GDP won't grow as fast, won't invest as much which leads to lower GDP *Consumption shouldn't change as much as income but investment seems to change a lot *In the long run, planned investment is how much investment there will be (people intend to do what they planned) *In the short-run, unplanned investment is possible *A rise in the market interest rate makes any given investment project less profitable so planned investment spending will decrease *Other things equal, firms will undertake more investment spending when they expect their sales to grow *When firms expect sales to grow rapidly they will undertake high levels of investment spending *A higher expected future growth rate of real GDP results in a higher level of planned investment spending Inventories: Stocks of goods held to satisfy future sales -Productive activity that hasn't been sold to a consumer yet -Inventories = kind of investment (need to have inventories to sell to consumers) -Amount of inventories isn't under firms' control (depends on how many consumers who up to buy things) -A firm that increases its inventories is engaging in a form of investment spending

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• Spring '08
• SALEHIE