1. Describe the difference between average propensity to consume and marginal propensity to consume.
2. List the factors that influence an individual's marginal propensity to consume.
3. Explain why we wouldn't expect investment to grow sufficiently to pull the economy out of a depression.
4. How do injections and withdrawals into an economy affect its income and output?
Aggregate demand is equal to the sum total of consumer spending, investment, government spending and net exports. The intersection of the aggregate demand and supply curves determines the level of national income in an economy. Any changes in consumption, investment, government spending and net exports will have an impact on aggregate demand and therefore national income.
Answer and Explanation:
1. Average propensity to consume is the proportion of a person's income that they spend on goods and services. Marginal propensity to consume (MPC) is the percentage of any additional unit of income a person earns that will be spent on consuming goods and services.
2. Factors influencing an individual's marginal propensity to consume include:
- The interest rate (a higher interest rate increases the attractiveness of saving relative to consumption)
- Consumer confidence (as consumer confidence increases, people feel more comfortable purchasing non-necessities. If consumer confidence is low, individuals might withhold spending to prepare for the future)
- Income level (a very poor person would be expected to have a high MPC as they may have insufficient money to pay for all basic necessities, whereas someone who is wealthier may be in a better position to save money)
3. A key determinant of investment is business confidence. In the midst of a depression, business confidence is likely to be extremely low. Therefore, businesses will probably withhold investment spending during a depression. Also, in a depression, businesses may face difficulties accessing credit, which reduced the ability of firms to invest.
4. Injections into an economy such as government spending, exports and investment lead to an increase in aggregate demand. This raises national income. Withdrawals, such as savings, taxes and imports reduce aggregate demand, reducing national income. The size of the impact of these factors on aggregate demand depends upon the marginal propensity to consume. The higher the marginal propensity to consume, the larger the multiplier effect (this is where a one unit increase in aggregate demand leads to a greater than one unit increase in national output). The size of the change in income and output also depends upon the elasticity of the aggregate supply curve. When the aggregate supply curve is elastic, changes in aggregate demand have a large impact on national income. When the aggregate supply curve is relatively inelastic, changes in aggregate demand will have little or possibly even no impact on national income.
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from Economics 102: MacroeconomicsChapter 7 / Lesson 3