Chapter 8, Problem 1P

To determine

Identify the concepts of MPC, actual investment, aggregative expenditure, and aggregative output.

Explanation of Solution

The marginal propensity to consume (MPC) is the fraction of a change in the income that is consumed or spent. The value of MPC lies between 0 and 1, while the value of multiplier shows the equilibrium output changes by a multiple of the change in the planned investment or any other exogenous variable. The value of multiplier is equal to the value of 1 divided by the marginal propensity to save. That is, $\frac{1}{1-\text{MPC}}$ .

A firm may not always end up investing the exact amount that it planned. The planned investment is the addition to the capital stock and the inventory that are planned by firms, while the actual investment is the actual amount of investment that takes place. The planned investment is different from the actual investment because of the unanticipated changes in the inventories and also the planned investment depends on the current interest rate.

The aggregative expenditure shows the total amount the economy spends in the form of consumption expenditure, investment expenditure, and the government expenditure, while the real GDP is the inflation adjusted value of the domestic products. At the equilibrium point, the planned aggregative expenditure is equal to the level of real GDP.

The aggregative output is the total quantity of goods and services produced in an economy in a given period, while the aggregative income is the income received by all the factors of production in a given period. The aggregative output and the aggregative income are the same just as the two sides of a coin.

Economics Concept Introduction

Marginal propensity to consume (MPC): Marginal propensity to consume refers to the sensitivity of change in the consumption level due to the changes occurred in the income level.

Multiplier: Multiplier refers to the ratio of change in the real GDP to the change in the initial consumption at a constant price rate. Multiplier is positively related to the marginal propensity to consume and negatively related to the marginal propensity to save.

Actual investment: The actual amount of investment that takes place include the items such as unplanned changes in the inventories.

Aggregative output: The aggregative output is the total quantity of goods and services produced in an economy in a given period.