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Questions and Answers on Income and Consumption - Paper Example

3 pages
731 words
Sewanee University of the South
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How do changes in income affect consumption (and saving)?

Fluctuations of income lead to corresponding changes in demand of commodities. The demand is also affected by the type of commodity involved. Demand for necessities for our daily life, for instance, is rarely influenced by any income changes. Luxury goods such as cars are more likely to be consumed when someones income increases. On the other hand, the individuals use of public transport will decrease due to increased income. The decision to consume or save as a response to income changes also depends on the preferences of an individual.

What are factors other than income that can affect consumption?

Changes in perceptions affect consumption. For instance, when consumers anticipate civil unrest, they will embark on a spending spree to stock up on food supplies. Demographic factors also influence consumption. People in rural areas have different expenditure patterns than those in rural areas. Families with young children are also likely to consume differently from those with older children. Other factors include credit terms, financial fiscal policies or unexpected financial booms.

How can changes in real GDP equilibrium occur in the aggregate expenditures model and how do these changes relate to the multiplier?

Real GDP equilibrium in the aggregate expenditures model is identified where the aggregate expenditures and real GDP are equal for a particular period. A change in the equilibrium can arise when the real GDP is greater than the aggregate expenditures. This will mean that there is more output than what is being planned for. Therefore, the output has to be reduced to get back to the equilibrium. If the aggregate expenditures are more than the real GDP, the economy will focus on more production to return it to the original equilibrium.

What is aggregate demand (AD) and why is its downward slope the result of real-balances effect, the interest-rate effect, and the foreign purchases effect?

Aggregate demand is the sum of all demands for goods and services by the economy in a certain period. The components of the AD are expenditures by governments, local firms, consumers and international businesses. The interest-rate effect causes a slump in the AD because high-interest rates reduce available credit to consumers hence their demand decreases. When foreign traders abandon doing business with the local economy, the AD falls too because foreign traders are a component of the AD. When a country makes more imports than exports, its AD shrinks due to the real-balances effect.

What is aggregate supply (AS) and why does it differ in the immediate short-run, the short-run, and the long-run?

Aggregate supply is the total price of all commodities produced by the economy at a specific time period. There is often a direct proportion between the commodity prices and intended supply. AS immediate short-run shifts are influenced by higher prices and demand for commodities. This is because businesses will be in a rush to produce more goods. It is affected in the short-run by increased wages due to improved employee motivation. In the long-run, AS is only affected by radical changes in capital investment such as in automation or outsourcing services. This is because the strategies lead to efficient production.

What are the purposes, tools, and limitations of fiscal policy?

Fiscal policy is the use of government expenditure and revenue to affect the economys growth. The first tool of fiscal policy is taxes. It is the main source of government revenue. Governments can trigger a change in the economy by either increasing or cutting down taxes in various sectors. Another tool is government expenditure in areas such as wages, subsidies, projects and welfare programs. Limitations of this policy include implementation challenges, equitable distribution of resources and complications in debt management.

How do economists integrate the international sector (exports and imports) into the aggregate expenditures model?

The international sector is included in the aggregate expenditures model using the net exports function. It is obtained by subtracting the total imports from the total exports. Since exports bring income to the economy, they are integrated into the model in a similar way to investments. An increase in net exports will, therefore, cause an upward shift of the curve of aggregate expenditures against real GDP. A decrease in the net exports will, on the other hand, cause a downward shift of the curve. Economists also consider the possibility that net exports can be an autonomous expenditure.


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