11 Classical and Keynesian Macro Analyses

• The classical model had an annual rate of inflation of 4 percent to 1 percent.
• There was a short-run determination of considerable variation in real GDP and the level of equilibrium real GDP and the price prices during this five-year interval.

• During the 73-year period, the prices of many other goods and services changed slightly, but since then the prices of most items, including Coca-Cola, have generally moved in an upward direction.

• The long-run assumption of fully adjusting prices is not retained by the Keynesian approach.
• The classical approach will be used to study variations in real GDP and the price level.

• The classical model was the first systematic attempt to explain the determinants of the price level and the national levels of real GDP, employment, consumption, saving, and investment.

• Pigou and others wrote from the 1700s to the 1930s.
• They assumed that wages and prices were flexible and that there were competitive markets throughout the economy.

• When you produce something for which you make money, you generate the income necessary to make expenditures on other goods and services.
• The income with which these goods and services can be purchased can be measured in base-year dollars.

• Classical economists argue that total national supply creates its own demand.

• Supply creates its own demand.

• The process of producing spe cific goods is proof that other goods are desired.
• People produce more goods than they want for their own use if they trade them for other goods.
• Someone offers to give something if he or she has a demand for something else.
• According to Say, this means that no general overproduction is possible in a market economy.
• It seems that full employment of labor and other resources would be the normal state of affairs in such an economy.

• Say acknowledged that there could be an oversupply of some goods.
• He argued that surpluses would cause prices to fall, which would decrease production.
• In markets where shortages temporarily appeared, the opposite would happen.

• A simple barter economy in which households produce most of the goods they want and trade for the rest seems reasonable.

• The circular flow of income and output is shown here.

• No, said the classical economists.
• They used a number of key assumptions.

• No one can affect the price of a commodity or input.

• Wages and prices are negotiable.
• As the economy adjusts, the assumption of pure competition leads to the idea that prices, wages and interest rates are free to move to whatever level of supply and demand dictate.

• People are driven by their own interests.
• Businesses and households want to maximize their economic well-being.

• People can't be fooled by money.
• Changes in rela tive prices affect buyers and sellers.

• If the price level has doubled during the same time period, then reacting to changes in money prices is better.

• The classical economists concluded that the role of government in the economy should be minimal after taking into account the four major assumptions.
• They are suffering from a money illusion.

• They argued that any problems in the economy will be temporary if that is the case.
• The market will correct itself.

• Income is not reflected in product demand when it is saved.
• It appears that supply doesn't create its own demand.

• An upward-sloping supply curve of saving is shown.

• The interest rate is the equilibrating force.

• Investment and Saving per Year were a problem.
• They claimed that businesses would invest each dollar saved in order to match the leakage of savings.

• The economists believed that businesses would invest as much as households would save.

• The classical economists' model shows equilibrium between the saving plans of consumers and the investment plans of businesses.
• The amount of credit demanded is equal to the amount of credit supplied.

• There is no reason to be concerned about Federal Reserve data on U.S. interest rates.

• The figure shows the rate of interest in percentage terms and the amount of desired saving and investment per unit time period.
• The supply curve of saving is the desired saving curve.
• People want to save more at higher interest rates than at lower interest rates.

• The higher the rate of interest, the less profitable it is to invest and the lower the level of desired investment.
• The investment curve slopes downward.
• The equilibrium rate of interest is 5 percent and the amount of savings and investment is $2 trillion a year.

• Consider the labor market.
• The wage level must be above equilibrium if there is an excess quantity of labor.
• The Bureau of unemployed workers will put back to work the latest U.S. saving rate if they accept lower wages.
• equilibrium is shown in the economic analysis.

• At $18 per hour, 160 million workers are employed.

• 170 million workers would want to work, but businesses would want to hire 150 million if the wage rate were $20 per hour.

• Employment isn't just an isolated figure that government statisticians estimate.
• The level of employment in an economy determines its real GDP.
• Table 11-1 shows a relationship between the number of employees and the value of output.
• The labor input is highlighted in the row with 160 million workers.
• It is related to a rate of real GDP, in base-year dollars, of 15 trillion per year.

• Unemployment greater than the natural unemployment rate is impossible in the classical model.
• It was defined as the real GDP that would be produced in an economy with full information and full adjustment of wages and prices year in and year out.

• There was no distinction between the long run and the short run.

• Real GDP is always at or soon to be at full employment because the labor market adjusts rapidly.
• The natural rate of unemployment is always 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609- 888-609-

• Any change in aggregate demand will cause a change in the price level.

• The level of GDP does not depend on demand.
• Real GDP is not affected by changes in aggregate demand.

• The price is 120.
• The real GDP at full employment is greater than the real GDP at full employment.

• The converse of the analysis just presented for an increase in aggregate demand is the effect of a decrease in aggregate demand in the classical model.

• The answers can be found on page 249.

• The classical model assumes that the quantity demanded is equal to the quantity that exists.
• The full-employment level of real GDP per year is associated with a completely flexible level of employment.

• When saving is introduced into the model, equilibrium changes in aggregate demand simply change the occurs in the credit market through changes in the interest.

• One of the fully utilized resources was the classical economists' world.
• There wouldn't be any unused capacity or unemployment.
• The classical model could not explain the economic decline of Europe and the United States in the 1930s.
• The Keynesian model was developed by John Maynard Keynes.
• Keynes and his followers argued that the price of labor was inflexible due to unions and long-term contracts between businesses and workers.
• Keynes said that in a world with excess capacity and unemployment, an increase in aggregate demand will not raise the price level, and a decrease in aggregate demand will not cause firms to lower prices.

• It would be a line that is consistent with full employment.

• Keynes assumed that prices will not fall when aggregate demand falls and that there is excess capacity.
• The equilibrium level of real GDP will be increased by 2.

• The equilibrium price level is 120.
• The equilibrium level of real GDP will increase to $15.5 trillion.
• The equilibrium level of real GDP will fall.

• The classical assumption of full employment is no longer valid.

• Between 1934 and 1940, the GDP deflator stayed in a range from 8.3 to less than 9.0, implying that the price level didn't change.
• In 2005 dollars, the level of real GDP was between $0.7 trillion and $1.1 trillion, or by more than 50 percent.
• Between 1934 and 1940, the U.S. short-run aggregate supply curve was almost flat.

• There is a fixed price for the short-run aggregate supply.

• The price level index is fixed in panel a.
• The equilibrium level of real GDP is $16 trillion per year in base-year dollars.

• The level of real GDP in base-year dollars is fifteen trillion per year.
• The equilibrium level of real GDP goes up to $16 trillion per year.

• The price level has risen in recent decades.
• Prices are not completely sticky.
• In the short run, price adjustment takes place.

• There is a relationship between incomplete price adjustment and the lack of information in the short economy.
• The curve is sloped.

• The equilibrium level of real GDP in panel is also at a price level of 120.
• A different short-run equilibrium can be produced by 2 such occurrences.
• The equilibrium real GDP increases to $15.5 trillion per year, which is less than in panel (a) because of an increase in the price level to 130.

• Most labor contracts call for flexibility in hours of work at a given wage rate.
• Firms can use existing workers to work harder, to work more hours per day, and to work more days per week.
• The difference between counted and uncounted is what is measured in the marketplace.
• There is no output if a worker cleans a machine.
• measured output will go up if that worker is put on the production line.

• The worker's production was counted.

• Capital equipment can be used more often.
• Machines can work more hours.
• Maintenance can be delayed.

• If wage rates are held constant, a higher price level leads to increased profits from additional production, which leads to firms hiring more workers.

• People who were previously not in the labor force can be persuaded to join it.

• As the price level increases, real GDP increases.

• There are non-price-level factors that can cause a shift in the aggregate supply curve.
• Aggregate supply curves will shift if anything other than the price level affects the production of final goods and services.

• The short-run aggregate supply curve and the long-run aggregate supply curve are affected by a core class of events.
• Changes in our endowments of the factors of production are included.
• In base-year dollars, 2 is $14.5 trillion of real GDP.

• There is a trade-off between changing production input prices and reducing those caused by external events that are not expected to last forever.
• Consider the effects of major hurricanes on the U.S. oil industry, as happened after Hurricane Katrina.
• In produc aggregate supply growth, oil is an important input.

• The higher price of oil is reflected in 2.
• The cost of production at each level of real GDP would need a higher price level to cover the increased costs.

• Table 11-2 contains a summary of the possible factors of aggregate supply.

• The short-run or long-run aggregate supply curve will be shifted depending on whether the determinants are temporary or permanent.

• The answers can be found on page 249.

• The economy is operating on horizontal information.
• It is upward sloping because it allows for only a short run aggregate supply curve.

• Keynes believed that a higher price level meant that profits, wages, and aggregate would not be increased.

• When there are shocks to the economy, we can use a basic model to evaluate short-run adjustments of the equilibrium price level and real GDP.

• The short-run equilibrium level of real GDP per year will fall to $14.8 trillion as the equirium price level falls to 115.
• There will be a $200 billion gap.

• The short-run equilibrium price level or real GDP level may change.

• The aggregate supply curve can shift inward or outward.

• When aggregate supply is stable but aggregate demand falls, we can show what happens.
• The unemployment rate will go up in the short run.
• The equilibrium price level is 120.

• The economy is in short-run equilibrium at less than full employment.

• Input prices will fall if there is too much unemployment.

• The run aggregate supply curve is a condition of an overheated economy.

• The inflationary gap is the difference of $200 billion.

• More can be squeezed out of the economy in the short run than in the long run.
• Firms will not be able to keep up with demand.
• People will be working too hard.
• Input prices will go up.

• In Chapter 10, we noted that in a growing economy, the explanation for persistent inflation is that aggregate demand rises over time at a faster pace than the fullemployment level of real GDP.

• Increases in aggregate demand cause inflation.

• Increases in aggregate side cause inflation.
• There is a leftward shift in the short-run aggregate supply.

• The equilibrium level of real GDP per year decreases from 15 trillion to $14.8 trillion as the price level increases from 120 to 125.

• The price goes up from 120 to 125.

• You should be able to see this in a graph.

• The U.S. economy's total capacity to pro changes constrained their ability to produce goods and services.
• In 2009, the nation's real value of goods and services that U.S. firms could produce at any price dropped by 1 percent.
• The U.S. aggregate supply curve shifted left as the largest per level declined.

• When the open economy was discussed in the early chapters of the book, we had to translate foreign currency into dollars.
• The dollar price of other currencies was used.
• The open economy effect is one of the reasons why the aggregate demand curve slopes downward.
• When the domestic price level goes up, U.S. residents want to buy foreign goods.

• The foreign sector of the U.S. economy makes up more than 14 percent of all economic activities.

• The dollar might become weaker in foreign exchange markets.
• A weaker dollar can lead to higher input prices if U.S. companies import raw and partially processed goods from Nigeria.
• The data from the Reserve Bank of New York shows how much natural gas the U.S. distributors purchase from suppliers in Nigeria.
• The dollar's value is changing relative to other currencies.

• The U.S. distributors have to pay a dollar price for every million of Nigerian natural gas imports because of the rate of exchange.
• If the U.S. dollar weakens against the Nigerian naira, then the price of the dollar will go up.
• The US dollar price of Nigerian natural gas imports increases to $150 million.

• The price level would rise and the equilibrium real GDP would fall.
• Employment would decrease.

• There is another effect that we must consider.
• Goods made in the U.S. are now less expensive in foreign currency.
• As a result of the dollar's weakness, the dollar can now only buy 0.67 euros.
• Before the dollar weakened, a U.S.-produced $10 downloadable music album cost a French resident 7.00 euros at the exchange rate of 0.70 euro per $1.

• A $10 digital album will cost 6.70 euro after the dollar weakens.
• The weaker dollar makes imported goods more expensive in the U.S.
• The result is more exports and less imports for U.S. residents.

• Equilib are two effects due to this effect.

• Real GDP may rise or fall as a result of a weaker dollar.

• The result is a tendency for the price level to go up and the unemployment rate to go down.

• The equilibrium price level rises.

• The equilibrium real GDP will rise if the aggregate demand curve shifts more than the short-run aggregate supply curve.
• The equilibrium real GDP will fall if the aggregate supply curve shifts more than the aggregate demand curve.

• You should be able to redo this analysis for a stronger dollar.

• The answers can be found on page 249.

• The aggregate demand curve can shift between how much the economy could be produced outward and how much it would take for the dollar to go up.
• The shift is larger when aggregate demand increases.

• Dalum Papir A/S has remained the same since the late 1970s.
• When oil prices suddenly go up, Den paper companies are one of the many ernment's intent, but now they make up half of the economy.
• The company uses a lot of energy shocks.

• The government's quest for materials for magazines is an example of the experience of Dalum Papir.
• Dalum Papir has had little choice but to maintain aggregate supply stability.
• Goods and services are more expensive because of government taxation.
• The Danes are more than 45 percent above the U.S. level.
• Dalum Papir must meet government-mandated stan shocks in order to grow their aggregate supply.

• High energy taxes and regulatory shocks have been enacted because of unexpected variations in energy prices.

• The Danes have 120 tons of oil per $1 million of GDP over the last 30 years, which is the same as other things being equal.

• Keynesian theories of the determination of real GDP and the price level offer different predictions about the relative importance of aggregate supply shocks.
• Real GDP is affected by shifts in the verti N Short Run versus Long Run cal aggregate supply curve.
• Keynesian theory suggests that changes in real GDP are caused by shifts in the aggregate demand curve.

• The results are consistent with classical theory.

• The principal components of variability in real GDP and the price level in the U.S. were identified by Balke.

Why do you think the quantity of money gate demand and supply shocks changes?

• The president's Council of Economic reports on households, firms, and the government.

• The conclusion is consistent with Keynesian theory.

• The price level in the United States can be tracked at www.econtoday.com/ch11.

• There is evidence that Draw three diagrams with aggregate demand, short-run aggre shock, changes in the quantity of money in circulation, is gate supply and long-run aggregate supply curves.
• To explain how a temporary increase in aggregate long run occurs, use the first determinant of changes in the price level in the diagram.

• A short-run change in real GDP can be generated by the real GDP decay and fiscal policy across sectors of the economy.
• The second diagram shows how a permanent increase in the quantity of money in circulation can be achieved.

• You should know what to know after reading this chapter.

• Video: Say's Law production can affect its price, wages are completely flexible, people are motivated by self-interest, and buyers and sellers don't experience money illusion.

• Real GDP can't increase without changes in long-term economic growth.

• The Animated Figures 11-6, 11-7 gate supply schedule can be horizontal.
• The short-run aggregate supply curve slopes upward if there is incomplete adjustment of prices.

• A shift in the shortrun aggregate supply curve can be caused by a temporary change in the prices of factors of production.

• An aggregate demand shock that Figure 11-9, 241 induces a rightward shift in the aggregate demand results in an inflationary gap.

• Cost-push inflation occurs when the aggregate demand curve shifts left.
• The short-run aggregate supply curve is leftward and the aggregate demand curve is rightward if the dollar weakens.

• Log in to MyEconLab, take a chapter test, and get a personalized study plan that tells you which concepts you understand and which ones you need to review.
• MyEconLab will give you further practice, as well as videos, animations, and guided solutions.

• The assumptions of the classical model match the current equilibrium interest rate.

• Consider a country with an economic structure supply curve and consumer and business confidence that is consistent with the classical plummets.
• The equi model has short-run effects.

• Support your answer.

• The classical model is appropriate for a short time.

• Any given interest rate could represent native-born residents.

• Explain your answers.

• Most workers in this nation's economy are true to the unemployment rate relative to union members, and unions have successfully negotiated large wage increases.

• If the stock market crashes in an econ reducing real GDP and disposable income in omy with an upward-sloping short-run aggregate other nations of the world.

• In an open economy, the aggre in production at many firms creates a major gate supply curve that slopes upward in the short run.

• Firms in this nation don't import raw materials services that have been produced before or any other productive inputs from abroad.
• The nation's central foreign residents purchase a lot of the nation's bank, pushing up the rate of goods and services.
• What is the most likely growth of the money supply?

How changes in the money supply should affect the annual percentage changes in these variables?

• The Federal Reserve Bank of St. Louis is related to monetary matters.

• The Federal Reserve Bank of St. Louis can be found at www.econtoday.com/ch11.

• Answer the questions after reading the article.

• The approach seems to get more money.

This drop in and explain how saving and consumption household expenditures followed on the heels of significant declines in the levels of wealth and wak Explain the key determinants of consumption and saving in the indebtedness of households

• The fall in real wak was caused by the Keynesian model decrease.

• Households spent more on goods and services than they earned.

• The fluctuations in a nation's real GDP are evaluated.

• We will assume that the short-run aggregate supply curve within the current range of real GDP is horizontal.
• We assume that it is the same as Figure 11-6 on page 236.
• The equilibrium level of GDP is determined by demand.
• Keynes wanted to look at the elements of desired aggregate expenditures.
• Inflation is not a concern because of the Keynesian assumption of inflexible prices.
• Real values are the same as nominal values.

• Businesses don't pay indirect taxes.

• Businesses give their profits to their shareholders.

• Gross private domestic investment is equal to net investment.

• There is no foreign trade in the economy.

• If you have a dollar of disposable income, you can either consume it or save it.
• You will be able to consume it if you save the entire dollar.

• Food and movies are consumption goods.
• Whatever is not consumed is saved.

• If you don't consume anything, you can consume at some time in food and go to a concert.

• It is important money.

• This rate is moving.

• Consumption is a flow concept.
• You use up after-tax income from goods bought by households at a certain rate per week, per month or per year.

• A dollar of take- home income can be spent or saved.

• Saving is the amount of disposable income that is not spent to purchase consumption goods.

• It is often used to describe putting money into the stock market or real estate.

• A future stream of income is expected.
• Changes in business inventories are included in our definition.

• The answers can be found on page 275.

• If we assume that we are operating in a stock market, that is a stock.
• The equilibrium level of from saving is the short-run aggregate supply curve.

• It's also a flow.
• Expenditures on ___________ is a flow that occurs over time.

• The rate of interest was used to determine the supply of saving in the classical model.
• The higher the rate of interest, the more people want to save and the less they want to consume.

• The main determinant of saving is income, not the interest rate.
• Keynes argued that real saving and consumption decisions are dependent on a household's disposable income.

• It shows how much each household will consume at each level.
• The facing page function tells us how much people plan to show a consumption function for a hypothetical household.

• The saving per year is shown by column 6.
• Column 7 shows are negative.
• Column 5 has a list of things to save.

• The planned saving of this hypothetical household is negative if the income is $60,000.

• Spending exceeds income in a negative saving situation.

• Table 12-1 presents the consumption and saving relationships.
• In the lower part of the figure, the horizontal axis is disposable income, but the vertical axis is savings per year.
• The point is that we are measuring flows, not stocks.

• What is not consumed is saved.

• We start by drawing a line that is equidistant from the horizontal and vertical axes.

• The line along which the income axis was planned is the same distance from the origin as the horizontal line.

• The consumption function can be found in Table 12-1 on the previous d page.

• The rate of real saving or dissaving at any income level is measured.

• The consumption function is above it.

• At a real disposable income level of $60,000, the planned annual rate of real saving is zero.

• The vertical distance between the consumption function and the 45 degree line can be used to calculate the rate of real saving or dissaving in the upper part of the figure.
• If our household's real disposable income falls to less than $60,000, it will not limit its consumption to this amount.
• It will either go into debt or consume assets to make up for lost income.

• The diagram shows a point where real disposable income is zero but planned consumption is $12,000.

• Independent income is part of consumption.
• The household will always attempt to consume at least $12,000 disposable income no matter how low the level of real income is.
• The consumption function is shifted by changes in consumption.

• Things other than the level of income determine the yearly consumption of $12,000.
• In our example, it is $12,000 per year because we state that it exists.

• In our model, consumption is not dependent on the household's disposable income.
• There are many different types of expenditures.
• We can assume that investment is independent of income.
• Government expenditures can be assumed to be autonomously.
• At times in our discussions, we will do that to simplify our analysis of income determination.

• Government economists always account for the current disposable income when forecasting total U.S. consumption, as they will engage in more consumption spending today at any given level of spending over the coming weeks and months.
• The University of Michigan's index of consumer consumption is used to do this.

• For any level of real income, the real consumption proportion of total real disposable income that is consumed is divided.

• For any given level of real income, the proportion of total real disposable income that is saved is divided by real disposable income.

• As income increases, the fraction of the household's real disposable income going to consumption falls.
• Column 5 shows that the average propensity to save is negative at first and then becomes positive after hitting an income level of $60,000.
• The value of theAPS is 0.1 at $120,000.
• The household saves 10 percent of their income.

• It's easy to figure out your average propensity to consume or save.
• If you divide the value of what you consumed by your total disposable income for the year, you will get your personal APC.

• Divide your real saving by your real disposable income to calculate your ownAPS.

• The Greek letter propensity to consume of 0.8 tells us that the marginal is a small decremental change.
• An additional $100 in take- home pay will lead to an additional $80 being consumed.

• The change in saving and disposable income are related.

• Out of an additional $100 in take- home pay, $20 change in real saving will be saved if the marginal propensity to save is defined as propensity to save of 0.2.
• Whatever is not saved is consumed.
• The marginal propensity to save must always be equal to the marginal propensity to consume.

• They tell you the percentage of the increase or decrease in real income that goes to consumption and saving.
• If there is a change in your real disposable income, the marginal propensity to consume will change.

• The average propensity to consume is the percentage of your total real disposable income that you consume.
• Table 12-1 shows that the APC is not equal to 0.8.
• It is not possible for the MPC to be less than zero or greater than one.
• Households increase their planned real consumption by between 0 and 100 percent of any increase in real disposable income that they receive.

• We can show the difference between the average propensity to consume and the marginal propensity to consume.
• Assume that your consumption behavior is the same as our household's.
• You have an annual disposable income of $108,000.
• The planned consumption rate from column 2 of Table 12-1 is $98,400.
• Your average propensity to consume is $98,400/$108,000.
• At the end of the year, your boss will give you an after-tax bonus of $12,000.
• According to the table, you would save over $2,500.

• A new consumption rate of $108,000 was added to find out.
• The average propensity to consume is $108,000, divided by the new higher salary of $120,000.

• In our simplified example, your MPC remains at 0.8 all the time.
• At every level of income, the MPC is 0.8.

• It is assumed that the amount that you are willing to consume out of additional income will remain the same in percentage terms no matter what level of real disposable income is your starting point.

• Saving must equal income.
• The change in total real disposable income is either consumed or saved.
• The proportions of the measures that are consumed and saved must be the same.

• The average propensities as well as the marginal propensities to consume and save must total 100 percent.
• The two statements should be checked by adding the figures in columns 4 and 5 for each level of disposable income.

• Do the same for columns 6 and 7.

• The consumption function will shift if there is a change in any other economic variable.
• The position of the consumption function can be determined by a number of nonincome factors.
• The stock of assets owned by a person will cause the average household's real net wealth to increase.
• A decrease in net wealth will cause it to shift downward.

• The consumption function of an individual or a consist of a house, cars, personal belongings, household is what we have been talking about so far.
• Let's move on to the national economy.

• People think that the government would rise if it acted like Robin.
• Hood would be caused by a redistribution of wealth.
• The distribution of wealth would not be accomplished by changing the consumption of high-income households.

• The answers can be found on page 275.

• The saving function is dependent on disposable income.
• The propensity to complement the consumption function because real save is equal to the change in planned real saving divided by real disposable income must equal real disposable by the change in real disposable income.

• The propensity to consume is the same as the rate of consumption to change.
• The consumption is divided by disposable income.
• The consumption function is what it is.
• The real saving change in a nonincome determinant of consumption will be divided by real disposable income.

• Changes in business inventories and expenditures on new buildings and equipment are part of investment.
• Real gross domestic investment in the United States has been volatile over the years.
• In the depths of the Great Depression and at the peak of the World War II effort, the net private domestic investment figure was negative.
• We weren't even maintaining our capital stock by fully replacing equipment.

• We find that the real investment expenditures are less variable over time than the real consumption expenditures.
• The real investment decisions of businesses are based on highly variable, subjective estimates of how the economic future looks.

• Businesses see an array of investment opportunities.

• The investment opportunities have rates of return ranging from zero to very high, with the number of projects being related to the rate of return.
• As the interest rate falls, planned investment spending increases, and vice versa, the project is profitable if its rate of return exceeds the opportunity cost of the investment.

• In our analysis, it doesn't matter if the firm must seek financing from external sources or use retained earnings.
• As the interest rate falls, more investment opportunities will be profitable, and planned investment will be higher.

• The investment function is represented as an inverse relationship between the rate of interest and the value of planned real investment.
• If the rate of interest is 5 percent, the dollar value of planned investment will be $2 trillion a year.

• On a per-year basis, the planned investment is shown as a flow, not a stock.

• Because planned real investment is assumed to be a function of the rate of interest, go to economic data provided by the Federal to see any non-interest-rate variable that can have the potential of shifting the Reserve Bank of St. Louis via the link at investment function.
• The expectations of businesses are one of those variables.
• You can see how the U.S. is depicted on www.econtoday.com/ch12

• The expectation of higher profits will lead to more investment.

• Investment function can be shifted by any change in productive technology.
• Changes in business taxes can change the investment schedule.
• We predict a leftward shift in the planned investment function if they increase because higher taxes imply a lower rate of return.

• The answers can be found on page 275.

• Changes in the non-interest-rate determinants of between real investment and planned investment will cause a slope.

• The non-interest-rate factors will be made.

• We want to figure out the equilibrium level of GDP per year.
• When we looked at the consumption function earlier in the chapter, it related planned real consumption expenditures to the level of real disposable income per year.
• In order to get real disposable income, adjustments must be made to GDP.
• Real disposable income is less than real GDP due to the fact that net taxes are usually 14 to 21 percent of GDP.
• The average disposable income in the last few years has been around 80% of GDP.

• There is a part of real consumption that is labeled.
• The change in the horizontal axis from real disposable income to real GDP per year is the difference between this graph and the graphs presented earlier in this chapter.
• Assume that 20 percent of changes in real disposable income is saved, and that an additional $100 earned will be eaten.

• The reference line is the same as in the earlier graphs.
• The quadrant is divided into two equal spaces by the 45 degree line.

• The rate of planned expenditures is shown in the consumption function.

• Real consumption and real GDP are the same.
• All real GDP is consumed at that GDP level.

• Changes in inventories of final products to the rate of interest are included in the planned investment function.
• We can treat the level of real investment as constant, regardless of the level of GDP, because we have a determinant investment level of $2 trillion at a 5 percent rate of interest.
• The vertical distance of investment spending is $2 trillion.
• Businesses will invest a certain amount of money no matter what the level of GDP is.

• When total planned real expenditures are equal to real GDP, equilibrium occurs.

• Real investment is not dependent on real GDP.

• For better exposition, we only look at a part of the saving and investment schedules--annual levels of real GDP between $9 trillion and $13 trillion.

• Reality confirms all anticipations.

• Only at the equilibrium level of real GDP of $11 trillion per year will investment, and hence planned saving equal planned saving equal actual saving, planned investment equal actual investment.

• Firms will be left with unsold products and their inventories will rise above planned levels.

• Unplanned business inventories will rise at a rate of $400 billion per year, or $2.4 trillion in actual investment, minus $2 trillion in planned investment by firms that had not anticipated an inventory build-up.
• This situation can't continue for a long time.
• Businesses will respond to the increase in inventories by cutting back production of goods and services and reducing employment, and we will move toward a lower level of real GDP.

• If real GDP is less than the equilibrium level, the adjustment process works differently.
• If real GDP is $9 trillion per year, an inventory decrease of $0.4 trillion will bring about an increase in real GDP towards the equilibrium level of $11 trillion.

• There will be an expansion of the circular flow of income and output in the form of inventory changes when the saving rate by households is different from the investment rate by businesses.
• The equilibrium level of real GDP is zero until inventory changes are again zero.

• The reason for the increase was that households wanted to save more.
• A cut in household spending resulted in an equal amount of unsold business inventories.

• The answers can be found on page 275.

• We assume that the consumption function has an Whenever planned saving exceeds planned investment part that is independent of the level of real and real GDP per year.

• GDP will fall as producers cut production.

• For simplicity, we assume that real investment is investment, there will be unplanned inventory, and real GDP will rise as producers increase unaffected by the level of real GDP per year.

• The level of real GDP can be found if planned saving and investment are combined.

• The role of government in our model has been ignored.
• The foreign sector of the economy has been left out.
• When we consider these as elements of the model, what happens?

• Federal government expenditures account for 25% of real GDP in the United States.

• Real taxes are used to pay for a lot of government spending.

• A tax that doesn't depend on income.
• In Table 12-2 we show the example of a $1,000 tax that every household numbers for a complete model.

• The nation's foreign trade deficit has been the focus of the media for a long time.
• We have been buying goods and services from foreign residents that are more expensive than what we are selling to them.

• The level of real exports depends on international economic conditions.
• Economic conditions at home affect real imports.

• There are trillions of dollars.

• We are in a position to determine the equilibrium level of real GDP per year under the continuing assumptions that the price level is unchanging, that investment, government, and the foreign sector are independent, and that planned consumption expenditures are determined by the level of real GDP.
• In Table 12-2 on the preceding page, we can see that total planned real expenditures of 15 trillion per year equal real GDP of 15 trillion per year, and this is where we reach equilibrium.

• When total planned real expenditures equal real GDP, equilibrium occurs.

• There are inventory changes when total planned real expenditures differ from real GDP.
• When total planned real expenditures are greater than GDP, there is a drop in inventory levels.
• Firms try to increase their production of goods and services in order to get inventories back up.
• Real GDP goes to its equilibrium level.
• The opposite occurs when total planned real expenditures are less than GDP.
• Firms have to cut back on their production of goods and services in order to push inventories back down to planned levels.
• The result is a drop in GDP.

• The answers can be found on page 275.

• For a closed economy at that level.
• Real GDP will be equal to total planned expenditures and net exports.

• When total planned real expenditures exceed real planned real expenditures are less than real GDP, there will be an inventory problem.

• The equilibrium real level of equilibrium real GDP will prevail because production of goods and services will increase.
• There will be a decrease in total GDP.

• Real consumption expenditures are the only real expenditures included in real GDP.

• Next, we add the amount of planned real investment, $2 trillion, and then figure out what the new equilibrium level of real GDP will be.
• It's $11 trillion per year.

• The effect of changes in spending is what is operating here.

• If there is a permanent increase in real GDP, it will cause a larger real expenditures.
• The number of changes in real investment or GDP.
• Even larger decreases in real GDP per year will be caused by permanent decreases in real spending.
• Let's look at a simple real GDP to understand why this multiple is used.

• The figures we used for the marginal propensity to consume and to save will be used again.
• The difference between the two will be 0.8, or 4, or 0.2, or 1.

• The first round of investment is increased by $100 billion.
• This also means an increase in real GDP of $100 billion, because the spending by one group represents income for another, shown in column 2.
• The increase in consumption by households that received additional income is given in column 3.
• The increase in real GDP is used to find this.
• During the first round, real consumption expenditures will increase by $80 billion.

• There's more to the story.
• $80 billion of additional income will be provided by this additional household consumption.

• During the second round, we see an increase in GDP of $80 billion.
• It will be more than twice as much as $80 billion.
• The equilibrium level of real GDP will increase by $500 billion after an initial increase in investment expenditures of $100 billion.
• A permanent $100 billion increase in real investment spending has led to an additional $400 billion increase in real consumption spending, for a total increase in real GDP of $500 billion.
• The equilibrium real GDP will change by five times the change in real investment.

• The marginal propensity to save is used to divide the spending multiplier.

• The MPS was equal to 0.2 or 1.

• That was our goal.
• A $500 billion increase in the equilibrium level of real GDP was caused by a $100 billion increase in real planned investment.

• You can always figure it out if you know the two.

• Let's look at an example.

• The following is due to the fact thatMPS is 1 and the following is due to the fact that it is 1 and the following is due to the fact that it is 1 and the following is due to the fact that it is 1 and the following is due to the fact that it is If we are given a marginal propensity to consume, we can always figure out the multiplier.

• The larger theplier, the smaller the marginal propensity to save.

• The bigger the marginal propensity to consume, the bigger the multiplier.

• When the marginal propensity to save is 3, 1, and 1 you can demonstrate this.

• The multiplier works for either a permanent increase or a permanent decrease in spending.
• The reduction in equilibrium real GDP would have been $500 billion per year if the component of real consumption had fallen permanently.

• It is possible that a relatively small change in planned investment can cause a larger change in equilibrium real GDP per year.
• The fluctuations in equilibrium real GDP are caused by changes in spending.

• The larger the marginal propensity to consume, the bigger the multiplier.
• The multiplier is 2 if the marginal propensity to consume is 1.

• The multiplier will be 10 if the marginal propensity to consume is 9.

• In the case in which the price level remains unchanged, our examination of how changes in real spending affect equilibrium real GDP has been done.
• Our analysis only shows how much the aggregate demand curve shifts in response to a change in investment, government spending, net exports, or lump-sum taxes.

• When we take into account the aggregate supply curve, we must also consider the responses of the equilibrium price level to a change in aggregate demand.
• If the price level remained at 120, the short-run equilibrium level of real GDP would increase to $15.5 trillion per year because of the $100 billion increase in spending.

• The new equilibrium level of GDP is $15.3 trillion.
• The effect on real GDP is smaller than the effect on nominal income because some of the additional income is used to pay higher prices.
• When the price level is fixed, not all is spent on additional goods and services.

• Any increase in aggregate demand will lead to a proportionally greater increase in the price level and a smaller increase in equilibrium real GDP per year.

• Most of the changes will be in the price level, so real GDP per Year will be relatively small.
• The price level will be raised by the strain on its productive capacity.

• Aggregate demand consists of consumption, investment, and government purchases.

• Let's assume the price level increases to 125 in the upper graph.

• The real-balance effect is when a higher price level decreases the purchasing power of cash.

• The interest rate effect means that it will be more costly for people to buy houses and cars if they try to borrow more to replenish their real cash balances.
• It is less profitable to install new equipment when interest rates are higher.
• The rise in the price level causes a reduction in planned spending on goods and services.

• Our higher price level causes foreign spending to fall in an open economy.
• It increases our demand for other people's goods.

• The answers can be found on page 275.

• The 8th Street Wine Company and Mortimer's Idaho Cuisine borrowed $25,000 to help pay for a used Toyota 4Runner during the mid-2000s.
• They ran up a lot of credit-card debts.
• The amount of unsold items grew at both schools.
• The Capps stopped taking their two children to restaurant when they realized that businesses were sending inventory rants and tried to cut their spending on utilities by using less accumulations.

• They stopped buying paper towels.

When they opened a new savings account with an initial and elsewhere throughout the United States, what did you deposit?

• The Capps and other families consumed less.
• Business production of new goods and ser saved more, local businesses began to experience unintended vices likely respond to the inventory build up.

• Aggregate U.S. real consumption spending fell between the end of 2007 and the beginning of 2009.
• Over the 18-month period, inflation-adjusted consumption decreased by nearly 2%.

• The inflation-adjusted value of housing measures is 1960, because the base year for these index was close to 8.
• The index value for wealth was almost 8 times higher in 2006 than it was in 1960.

• Real disposable income began to increase in late 2009.
• The index grew at a slow pace after 2007.
• How do you think disposable income decreased?

Figure 12-9 shows that real housing wealth, real going back as far as 1947, can be found at www.econtoday.com/ch12

• Discuss how changes in household debt after 2006 affected movements in the U.S.

• Real consumption fell in the late 2000s because disposable income and household wealth declined.
• The reasons for the fall in real household consumption are listed.

• The value of corporate stock in the study plan held by households rose in late 2009.
• What do you think about Section N: News?

• You should know what to know after reading this chapter.

• Chapter 12 savings is a stock of resources.

• The portion of disposable income you don't consume during a week, a month, or a capital goods year is an addition to your stock of savings.
• Saving during a year plus consumption during that year must equal disposable income earned that year.

• There is an Animated Figure 12-1 consumption unrelated to disposable income.

• The marginal propensity to save is divided by the change in disposable income and the change in consumption consume.

• Business expectations, productive technology, and business taxes can cause the investment schedule to shift.
• Changes in real GDP do not affect investment.

• There is no tendency for business inventories to expand or contract in a world without government spending and taxes.

• As consumption increases, so does real GDP.
• The expansion of real GDP is equal to the increase in expenditures.

• 269 households and businesses cut back on spending because of an increase in the price level.

• The aggregate demand curve is downward-sloping.

• Log in to MyEconLab, take a chapter test, and get a personalized study plan that tells you which concepts you understand and which ones you need to review.
• MyEconLab will give you further practice, as well as videos, animations, and guided solutions.

• Classify each of the following as either a stock or a level of real GDP, and investment spending is flow.

• There is no government.

• Myung Park makes $850 per week.

• Giorgio is the owner of three private jets.

• The marginal Monetary Fund is what it is.

• A graph of the consumption function can be drawn.

• The saving and investment curves are shown.

• The saving and investment 4 and the real consumption spending curves cross in the lower graph if the multiplier is equal to real GDP.

• The households pay no taxes.

• When the price level falls to a value of 120, total lowing questions, consider the table below.

• 0.75 is the marginal propensity to consume.

What is the level of GDP at the new point?

• There is no government.

• The aggregate demand curve shows the price at 100 and real GDP at 15 trillion.

• A graph of the consumption function can be drawn.

• The diagram on the top of the facing of real GDP shows the saving and investment page, which applies to a nation with no govern curves, at the equilib ment spending, taxes, and net exports.

• To determine the relative extent to which taxes do not vary with income, your task is to evaluate how reasonable this assump values are for the marginal propensity to consume.

The data can be found at www.econtoday.com/ch12

• Discuss each group's ditures for the past eight quarters as a class.
• Go back and look at this issue.

• If we look at Figure C-1 below, we can see a small section of the graphs that we used in Chapter 12. equilibrium real GDP is $14.5 trillion per year.
• The $100 billion increase in investment is represented by the vertical shift.
• Inventories are falling.
• As firms try to replenish their inventories, production of goods and services will increase.

• Real GDP will catch up with total expenditures eventually.
• The equilibrium level of GDP is fifteen trillion dollars a year.
• The increase in equilibrium real GDP is equal to five times the increase in planned investment spending.

• The investment of $100 billion is C + I + G + X.

• The level of real GDP is fifteen trillion.
• C + I + G + X is established again.