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McConnell Economics, Chapter 9

Posted: Sun Dec 29, 2019 11:29 pm
by Jin+Guice
Discussion of the curriculum McConnell, Brue, Flynn Economics text, chapter 9.

Re: McConnell Economics, Chapter 9

Posted: Wed Apr 15, 2020 9:04 am
by Jin+Guice
Chapter 9 outlines the aggregate supply model. In this simplified model, producers will only produce the amount of goods and services that are consumed. Consumer income can only be use for consumption or savings. So Income= Consumption + Savings.
The "average propensity to consume" is defined as the percentage of income that is consumed while the "average propensity to save" is defined as the percentage of income saved. As income is increased APS increases, on average. The "marginal propensity to consume" is defined as the (change in consumption)/ (change in income) and the "marginal propensity to save" is defined as the (change in savings)/ (change in income). The marginal propensities address how savings and consumption change as income changes.

In addition to income the text highlights several other factors which influence a households save/ consume decision. These include wealth (wealth up, APC up), expectations about future prices (future expected prices up, APC up), expectations about future household income (future expected income down, APC down), household debt (debt up, APC up), taxation (unclear, but treated the same as a shift in income). When considering these shifts it's important to remember that all income is either spent or saved in the current period, and all changes are "in the current period." Thus raising household debt allows more consumption today, while an expected rise in relative future prices causes more consumption today (to take advantage of current prices).

The next section discusses investment in capital goods by businesses. In economics the "real interest rate" (as established by the Fed in the U.S.) represents the "risk-free return on capital," thus other investments will only take place if the expected return of an investment exceeds the risk-free rate. The book uses different interest rates to derive an "investment demand" curve, which shows that the lower the risk-free interest rate, the higher investment will be. Other factors influencing investment (which will shift the "investment demand curve) are: the cost of maintaining and operating capital goods (lower costs, higher investment), business taxation (higher taxes, lower investment), technological change (better technology, higher investment), the existing stock of capital goods (underutilized existing capacity, investing down) and business expectations (rosier future, more investment).

In the model created in the book, the economy will always tend towards equilibrium. If demand is higher than supply, it will be profitable for firms to produce more to meet demand and if supply is greater than demand, suppliers will reduce output or lose profit. In the equilibrium state consumption + investment= GDP and Investment=Savings.