Consumption & Saving

Disposable Income:

• Income after taxes (net income)
• DI = gross income - taxes
• One can only spend or save DI
• Consume: spend on goods and services
• Save: not spend

Consumption:

• Household spending 
• Ability to consume constrained by:

              - amount of disposable income
              - propensity to save

• Do households consume if DI = 0? -Autonomous Consumption

Saving:

• Household not spending 
• Ability to save constrained by:

              - amount of DI
              - propensity to consume

• Do they save if DI = 0? -No

APC & APS:

• APC + APS = 1 
• 1 - APC = APS
• 1- APS = APC
• APC < 1 = dissaving
• -APS = dissaving

Marginal Propensity to Consume (MPC):

• fraction of any change in DI consumed 

MPC = Δ consumption
                    Δ DI

Marginal Propensity to Save (MPS):

• fraction of any change in DI saved

MPS = Δ savings
                Δ DI

MPC + MPS = 1 

1 - MPC = MPS

1- MPS = MPC

Spending Multiplier Effect:

• initial change in spending (C+Ig+G+Xn) causes larger change in AD (ag. spending)

Multiplier =      Δ AD

                   Δ spending

Spending Multiplier = 1/MPS

• (+) when increase in spending
• (-) when decrease in spending

Tax Multiplier:

• when the government taxes, multiplier works in reverse because money leaves the circular flow chart

Tax Multiplier = -MPC/MPS

• Answer will always be negative (-)
• Unless it's a tax cut, then it will be (+) because there is more in the circular flow

Investment Overview

Money spent or expenditures on:

• new plants (factories)
• capital equipment (machinery) 
• technology (hard & soft)
• new homes
• inventories (goods sold by producers)

Expected Rates of Return:

• How does business make investment decisions?

           - Cost/Benefit Analysis

• How does business determine benefits?

          - Expected Rate of Return

• How does business count the cost?

           - Interest Costs

• How does business determine the amount of investment they undertake?

         - compare expected return to interest
              - return > cost = invest
              - return < cost = do not invest 

Real (r%) v. Nominal (i%): 

           nominal is observable rate if interest, real subtracts inflation (π%) and is known as ex post facto

• How do you compute the real interest rate?

         - r% = i% - π%

• What determines the cost of investment?

         - real interest rate (r%)

Investment Demand Curve (ID):

• What is the shape?

         - downward sloping

• Why?

         - when interest is high, fewer investments are profitable; when interest rates are low,              more investments are profitable

Aggregate Graphs

Full Employment:

Full employment equilibrium exists where AD intersects with SRAS and LRAS

Recessionary Gap:

exists when equilibrium occurs below full employment output

Inflationary Gap:

exists when equilibrium occurs beyond full employment output

Keynesian Model:

Keynesian (Recession):

• Prices; fixed
• Wages; fixed
• Employment; flexible 
• Depends on changes in employment level

Classical/Vertical (Inflation):

• Price; flexible
• Wages; flexible
• Employment; fixed
• Independent of changes in price level

Nominal Wages:

• amount of money received by a worker per unit of time

Real Wages:

• amount of goods and services that a worker can purchase with their nominal wages 
• purchasing power of nominal wages

Sticky Wages:

• nominal wage level set according to an initial price level that does not vary due to the labor contracts or other restrictions

Classical vs Keynesian Video for Referance

Classical vs. Keynesian

Classical:

• Competition is good
• Self-regulating economy
• Long Run; economy balanced at full employment 
• Supports trickle down effect; rich first 

Keynesian:

• Competition is flawed 
• AD is key, not AS
• Leaks and savings cause recessions
• Ratchet effect and sticky wages blocks Say's Law
• Long Run; we are dead

Aggregate Supply

-Level of Real GDP that firms will produce at each given Price Level (PL)

Long Run v. Short Run

Long Run:

• Period of time where input prices are flexible and adjust to changes in the price level
• Level of Real GDP supplied is independent of the price level

Short Run:

• Period of time where input prices are sticky and do not adjust to price level change
• Level of Real GDP is directly related to the price level

Long Run Aggregate Supply (LRAS)

• Marks level of full employment in economy (analogous to PPC)
• Because input prices are flexible, changes in price level do not change firms' real profits and therefore do not change a firms' level of output. LRAS is vertical at full employment  

Changes in SRAS (Short Run)

• Increase is to the right; Decrease is to the left 

per unit cost of production = total input cost 

                                          total output

Determinants:

1.) Input Prices

          -Domestic Resource Prices

               - wages (75% of business costs)

               - cost of capital

               - raw materials (commodity prices)

          -Foreign Resource Price

               - Strong $ = lower foreign resource price

               - Weak $ = higher foreign resource price

          - Market power 

               - increases in resource prices = SRAS shift to the left

               - decrease in resource prices = SRAS shift to the right

2.) Productivity

total output

total input

          - More productivity = lower unit prod. cost: SRAS shifts right

          - Less productivity = higher unit prod. cost: SRAS shifts left 

3.) Legal-Institutional Environment

          - Taxes and Subsidies

               - tax on business increase per unit prod. cost = SRAS shift left

               - subsidies to business reduce per unit prod. cost = SRAS shift right 

          - Government Regulation

               - gov't regulation creates cost of compliance = SRAS shift left 

               - deregulation reduces compliance cost = SRAS shift right

Aggregate Demand Curve

-Changes in the price level cause a move along the curve
Demand by consumers, businesses, government, and foreign countries.


AD Downward Sloping because-

Real Balance Effect: 

• higher price levels reduce purchasing power 
• this decreases the quantity of expenditures
• lower price levels increase purchasing power and increase expenditures 

Interest Rate Effect:

• when price level increases, lenders need to charge higher rates to get a REAL return on their loans
• higher interest rates discourage consumer spending and business investment 

Foreign Trade Effect:

• when US price level rises, foreign buyers purchase fewer US goods and Americans buy more foreign goods
• exports fall and imports rise causing all real GDP demanded to fall

Shifters of Aggregate Demand:

• 2 parts in a shift in AD

          - A change in C, Ig, G, and/or Xn 

          - A multiplier effect that produces a greater change than the original in the four                         components  

• Increase = to the right 
• Decrease = to the left 

Determinants of AD:

• Consumption

          -Household Spending affected by:

                 - consumer wealth

                      - more income = more spending; Ad shifts right

                      - less income = less spending; AD shifts to the left

                 - consumer expectations

                     - positive expectations = more spending; AD shifts right

                     - negative expectations = less spending; AD shifts to the left

                 - household indebtedness

                     - less debt = more spending; AD shifts right

                     - more debt = less spending; AD shifts to the left

                 - taxes

                     - less taxes = more spending; AD shifts right

                     - more taxes = less spending; AD shifts to the left 

• Gross Private Domestic Investment

          -Investment Spending sensitive to:

                 - Real Interest Rate

                    - lower rate = more investment; AD shifts right

                    - higher rate = less investment; AD shifts to the left

                 - Expected Returns

                    - higher returns = more investment; AD shifts right

                    - lower returns = less investment; AD shifts to the left

                     - Influenced by:

                        - future expectations of a profit

                        - technology

                        - degree of excess capacity

                        - business taxes

• Government Spending

          - more spending = AD shifts right

          - less spending = AD shifts to the left 

• Net Exports

          - Exchange Rates

                - stronger $ = more imports, less exports; AD shifts to the left

                - weaker $ = less imports, more exports; AD shifts right

   

          - Relative Income

                - strong foreign economy = more exports; AD shifts right 

                - weak foreign economy = less exports; AD shifts to the left 

Types of Unemployment Video

https://www.youtube.com/watch?v=US808k1ghV4&index=12&list=PLB8F4339BE0534D6F

Calculating CPI Video

https://www.youtube.com/watch?v=IvR2SITtIjY

Unemployment/Okun's Law/ Rule of 70

Unemployment:

-  It is the failure to use available resources, particularly labor, to produce desired goods & services

Underemployment:

-  Working less than 12 hours

Part-time:

-  Working 12-15 hours

People in the Labor Force:

-  Above 16 years of age

-  Able & willing to work

Not Included in Labor Force:

v  Military

v  Students

v   Retired

v   Disabled

v   Homemakers

v   Mental Institutions

v  Jail/Prison

v  Those Who Aren’t Looking for a Job

Unemployment Rate: 4 to 5%= Full Employment or Natural Rate of Unemployment (NRU)

How to Calculate Unemployment Rate:

               # of unemployed/(# of employed + # of unemployed)×100

Types of Unemployment

Frictional	Structural	Seasonal	Cyclical
-Those who are searching for a job -Temporary unemployed or in between jobs -Have transferable skills - Ex. College//high school graduates, laid off from your job or you leave or job	-  Changes in the structure of the labor force that make some skills obsolete - DO NOT have transferable skills -  Has to learn new skills to get a job	-Due to the time of year and nature of the job - Ex. School bus drivers, lifeguards, Santa Claus/Easter Bunny impersonators, construction workers	- As demand for goods and services falls, demand for labor falls & workers are laid off

v  Frictional + Structural Unemployment= NRU

v  full Employment means there is NO cyclical unemployment

GDP Gap: The amount by which actual falls short of potential GDP

Okun’s Law: For every 1% in which the actual unemployment rate exceeds the NRU a GDP gap of about 2% occurs

Rule of 70:  It is used to determine how many years it takes for a value to double given a particular annual growth rate.

70/interest rate= # of years

GDP The Basics Video

https://www.youtube.com/watch?v=32dyopVAOJY

GDP/GNP

Firms: It is an organization that produces goods & services for sale

Household: A person or group of people that share their phone

Gross Domestic Product (GDP): It is the market value of all final goods & services produced within a nation in a given year

What isn't Included in GDP

• Intermediate Goods- something that needs further processing
• Used or Second-hand Goods- has been counted before
• Purely Financial Transactions- stocks, bonds, etc.
• Illegal Activities- drugs money, etc.
• Unreported Business Activity- tips
• Nonmarket Activities/Transactions- volunteering, babysitting
• Transfer Payments- scholarships, welfare payments, social security

What is included in GDP

C- Personal Consumption Expenditures (65% Americans spend on)

Ig- Gross (Total) Private Domestic Investment (17%)

• Factory Equipment Maintenance
• New Factory Equipment
• Construction of Housing
• Unsold Inventory or Products built in a Year

G- Government Spending (20% of American economy)

Xn- Net Exports (2%) (Exports-Imports)

Gross National Product (GNP): Total market value of all final goods & services by citizens of that country on its land or foreign land

Two Ways to Calculate GDP

1.    Expenditure Approach

-       Add up all of the spending on final goods & services produced in a given year formula:

GDP= C+Ig+G+Xn

“expenditure”- to spend

2.    Income Approach

-       It adds up all the income that resulted from selling all final goods & services produced in a given year formula:

W +R +I+ P+ statistical adjustments

W- wages

R- rents

I-  interests

P- profits

Statistical Adjustments

1.            Indirect Business Taxes

2.            Depreciation AKA Consumption of Fixed Capital

3.            Net Foreign Factor Payment

Compensation of Employees: Wages & salaries, could also include pensions, insurance, health & welfare

Rents: Income received by property owners

Interest

-Money paid by private businesses to the suppliers of loans

Corporate Profits

-It is the income of the corporation’s stockholders Ex. Dividends & corporate income taxes

Proprietor’s Income

-income that comes from entrepreneurships & partners in a business

Formulas:

-Budget Surplus/Deficit = Gov. Purchases of Goods & Services + Gov. Transfer Payments – Gov. Tax & Free Collection

-Trade Surplus/Deficit = Exports – Imports

National Income =

1.    Compensation of Employees + Rents + Interests + Corporate Profits + Proprietor’s Income

2.    GDP – Income Business Taxes – Depreciation – Net Foreign Factor Payment

Disposable Personal Income = National Income – Personal Household Taxes + Gov. Transfer Payments

-Net Domestic Product (NDP)= GDP – Depreciation

Net National Product (NNP)= GDP + Net Foreign Factor Payment

Nominal GDP	Real GDP
o   (price × quantity) o   The value of output produced in current year prices o   Used to measure an increase in prices o   Can increase from year to year if either price or quantity increases	o   (base yr. price × current yr. quantity) o   The value of output produced in constant base year prices o   ADJUSTED for inflation o   Used to measure economic growth o   Can increase from year to year only if output increases

GDP Deflator:

- It is a price index used to adjust from nominal to real GDP

Nominal GDP ×100                                    Nominal Interest Rate ×100

   Real GDP                                                   Real Interest Rate

- In base year, GDP Deflator ALWAYS equals 100

- For years after the base year, GDP deflator is greater than 100

- For years before the base year, GDP deflator is less than 100

Consumer Price Index (CPI):

- Most commonly used measurement of inflation

- It measures the cost of a market basket of goods of a typical urban American family

(cost of a market basket of goods & services in a given year) ×100

(cost of a market basket of goods in a base year)

Inflation Rate:

New Price Index – Old Price Index/Old Price Index

Nominal Interest Rate:

-  The percentage increase in money, the borrower must pay a lender for a loan

- It is NOT adjusted for inflation

Real Interest Rate (RIR):

- The percentage increase in purchasing power, the borrower must pay the lend for a loan

- It IS adjusted for inflation

Formulas:

RIR= Nominal Interest Rate – Inflation

Nominal Interest Rate= Expected Interest Rate + Inflation Premium       

Hurt by Inflation

§     Savers

§     Lenders/Creditors

§     People who are on a Fixed Income Ex. Elderly, welfare

Helped by Inflation

§  People who Owe Money Ex. Debtors

C.O.L.A.

o   Cost of living adjustments

o   It is where you get an automatic wage increase when inflation occurs

Business Cycles

 Peak- is the highest point of the real GDP; greatest amount of spending and lowest amount of unemployment. In this phase inflation becomes a problem

 Expansion- real GDP is increasing due to an inflation of spending and a decrease in unemployment

 Contraction- real GDP declines for 6 months due to a reduction in spending and increase in unemployment

Trough- is lowest point of real GDP; least amount of spending & highest unemployment

Equillibium

Equilibrium- is the point at which the supply curve and the demand curve intersect.  At this point, all resources are being efficiently used.
 
Excess demand- occurs when the quantity demanded is greater than the quantity supplied.  This will result in shortages, where consumers cannot get the quantities of items that they desire.

Excess Supply-when the quantity supplied is greater than the quantity demanded, creates surplus

Price ceiling- creates a shortage and occurs when the government puts a legal limit on how high the price of a product can be.
Excess supply- occurs when the quantity supplied is greater than the quantity demanded.  This will result in a surplus, where producers have inventories they cannot get rid of.
 
Price floor- is the lowest legal price a commodity can be sold at. This creates a surplus and is used by the government to prevent prices from being too low.

Supply and Demand

Cause of Change in Supply

• change in technology
• change in weather
• change in cost of production
• change in number of sellers
• change in taxes or subsidies
• change in expectations

 

Cause of Change in Demand

• change in buyer’s taste (advertisement)
• change in number of buyers (population)
• change in income (normal goods/inferior goods)
• change in price of related goods (complementary/supplementary)

Supply:is the quantities that producers or sellers are willing and able to produce at various places.
Law of Supply:There is a direct relationship between product and quantity supplied.
Demand is the quantities that people are willing and able to buy at various prices.   Law of Demand There is an inverse relationship between price and quality demanded   Normal Goods-increases income; causes an increase in demand   Inferior Goods-Increase in income; causes a fall in demand   Complementary Goods-ex: fish and chips   Supplementary Goods-ex: white bread replaced by wheat bread  Supply and Demand: Gallon of Milk (VIDEO LINK)