Economics exam 3 study guide

# Aggregate demand is the sum of c i g x im national

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Aggregate demand is the sum of C + I + G + (X – IM) National income : income of all individuals before-tax Disposable income (DI) : income of all individuals after-tax o how much consumers have available to spend or save the circular flow of spending, production and income circular flow diagram o consumers disposable income: consumption (C) Saving (S): Spend less than save Financial system (banks, mutual funds) investment spending from investors (business firms and home buyers) and total C increase + I government adds demand (G) C + I + G rest of the world adds imports and exports C + I + G + ( X – IM) o aggregate demand arrives at business firms to produce domestic product gross national income comes out ( national income and domestic product must be equal) why? Payments to individuals are income and the rest is profit for firm, but because they are citizens their income also counts. So all wages, rents and profits are added up in

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the economy to obtain the national income, and arrive at the value of output national income leaves firms and heads to consumers government takes a portion before government adds back transfer payments : sums of money that the government gives certain individuals as outright grants rather than as payments for services rendered to employers (SSS, unemployment benefits) DI = GDP – Taxes + Transfer Payments o =GDP – (Taxes – Transfers) o =Y –T Y: GDP and T: net taxes The consumption function and the marginal propensity to consume Consumption function : shows the relationship between total consumer expenditures and total disposable income in the economy holding all other determinants of consumer spending constant Marginal propensity to consume (MPC) : is the ratio of the change in consumption relative to the change in disposable income that produces the change in consumption. On the graph it appears as the slope of the consumption function. o MPC= change in C / change in DI that produces the change in C o To estimate the initial effect of a tax cut on consumers spending, economists must first estimate the MPC and then multiply the amount of the tax cut by estimated MPC. Because they never know the true MPC with certainty, their prediction is always subject to some margin of error Factors that shift the consumption function Change in price causes a movement along the demand curve o A change in disposable income leads to a movement along the consumption function Because consumption function depicts relationship between C and DI o Any change in DI moves us along a given consumption function. A change in any of the other determinants of consumption shifts the entire consumption schedule. Wealth : source of purchasing power in addition to income.
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