What is the relationship between the MPC and MPS?

a) their amount is equal to disposable income;

b) the relationship between them characterizes the average propensity to consumption;

c) their sum equals 1;

d) their sum is 0.

 

Numerical tasks

1. For each of the following events, draw a curve representing the consumption function and show how the event would affect the curve.

1. A sharp increase in stock prices increases the real wealth of most households.
2. Consumers decide that a recession is ahead and that their incomes are likely to fall.
3. The price level falls.

2. Suppose you are given the following data for an economy. All data are in billions of dollars.

Y is actual real GDP, and C, I _P, G, and Xn are the consumption, planned investment, government purchases, and net exports as components of aggregate expenditures, respectively.

 

Y	C	Ip	G	Xn
$0	$800	$1,000	$1,400	-$200
2,500	2,300	1,000	1,400	-$200
5,000	3,800	1,000	1,400	-$200
7,500	5,300	1,000	1,400	-$200
10,000	6,800	1,000	1,400	-$200

 

1)  Plot the aggregate expenditures curve and draw in the 45-degree line. 2) What is the intercept of the AE curve? 3) What is its slope? 4) Determine the equilibrium level of real GDP.

Now suppose that net exports fall by $1,000 billion and that this is the only change in autonomous aggregate expenditures. 5) Plot the new aggregate expenditures curve. 6) What is the new equilibrium level of real GDP? 7) What is the value of the multiplier?

Chapter 9. Investment and Economic Activity

Unit 9.1 The Role and Nature of Investment

Learning objectives

Discuss the components of the investment spending category of GDP and distinguish between gross and net investment.

2. Discuss the relationship between consumption, saving, and investment, and explain the relationship using the production possibilities model.

Investment adds to the nation’s capital stock. We saw in the chapter on economic growth that an increase in capital shifts the aggregate production function (PF) outward, increases the demand for labor, and shifts the LRAS curve to the right. Investment therefore affects the economy’s potential output and thus its standard of living in the long run.

Investment is a component of aggregate demand. Changes in investment shift the aggregate demand curve and thus change real GDP and the price level in the short run. An increase in investment shifts the aggregate demand curve to the right; a reduction shifts it to the left.

Components of Investment

Additions to the stock of private capital are called Gross Private Domestic Investment (GPDI). GPDI includes four categories of investment:

1. Nonresidential Structures includes the construction of business structures such as private office buildings, warehouses, factories, private hospitals and universities, and other structures in which the production of goods and services takes place. Recall that investment is part of GDP, and GDP is the value of production in any period.

2. Nonresidential Equipment and Software. Producers’ equipment includes computers and software, machinery, trucks, cars, and desks, that is, any business equipment.

3. Residential Investment. This category includes all forms of residential construction, whether apartment houses or single-family homes, as well as residential equipment such as computers and software.

4. Change in Private Inventories. Private inventories are considered part of the nation’s capital stock, because those inventories are used to produce other goods. All private inventories are capital; additions to private inventories are thus investment. When private inventories fall, that is recorded as negative investment.

Gross and Net Investment

As capital is used, some of it wears out or becomes obsolete; it depreciates; depreciation being “consumption of fixed capital”. Investment adds to the capital stock, and depreciation reduces it. Gross investment minus depreciation is net investment. If gross investment is greater than depreciation in any period, then net investment is positive and the capital stock increases. If gross investment is less than depreciation in any period, then net investment is negative and the capital stock declines. In the official estimates of total output, gross investment (GPDI) minus depreciation equals net private domestic investment (NPDI).