MPC, Consumption Function, & Gaps

Unit 3 Chapter 25 & 26 MPC, Consumption Function, & Gaps

Marginal Propensity to Consume(MPC) • Definition: the ratio of change in C from a change in DI, that caused the change in C • MPC = C/ DI = Slope of Consumption Function

Consumption Function • Movement along • Changes in DI cause changes in consumption – move from point to point on CF (A to B) B A

CF (Cont.) • Shifts of the line • Caused by a change in C that is not because of a change in DI • 3 factors • Expectations of future outcomes • Value of wealth/accumulation of assets • Price levels/purchasing power CF1 CF0

Aggregate Expenditure Schedule • C + I + G + (X-IM) • Reflects total expenditure at all levels of GDP • Equilibrium GDP • Spending = output

Inflationary Gap 45 * • EGDP > PGDP • Spending too high • Price levels too low • Result • Inflationary gap formed • Inflation increases C + I + G + (X-IM) Inflationary Gap PGDP EGDP • How to Fix it • Increase price levels • Increase taxes • Reduce government spending

Recessionary Gap 45 * • EGDP < PGDP • Spending too low • Price levels to high • Result • Recessionary gap • Unemployment rises C + I + G + (X-IM) Recessionary Gap EGDP PGDP • How to fix it • Cut taxes • Lower price levels • Increase government spending

When we have a recession… • …they also recess abroad • We have less money to spend on imports • Decreases exports for foreign countries • Exports decrease, AD decreases, GDP decreases… RECESSION

MPC, Consumption Function, & Gaps