Chapter 2: The Basic Model 1 - Consumers, Producers, and Government

Question 1

What does the Keynesian theory of income determination focus on

Answer 1

• focuses on the real (goods) sector (activities like production, consumption, saving, investment, exports, imports)
• it also explains determination of changes in the total production (GDP) and real income (Y) in the short run.

Question 2

What is the original Keynesian approach of income determination

Answer 2

• expenditure determines production (demand determines supply)
• each level of production implies a corresponding level of income
• income-expenditure circular flow illustrates the Keynesian approach

Question 3

What are the three types of transactions in the good sector

Answer 3

1. Goods market transactions (buying products from the store)
2. Labour market transactions (paying employee wages)
3. Capital transactions (buying shares)

Question 4

What are factors of production that also represents income for households

Answer 4

Labour and capital

Question 5

What does the basic framework focus on

Answer 5

• It focuses on only the flows of income and expenditure (and aggregate all transactions between households and firms)

Question 6

What represents the chain reaction

Answer 6

The level of expended had determines the production level:
- an increase in expenditure (demand/spending) leads to > less than production demanded
- stocks are depleted then producers produce more (real GDP and employment increase)
- Real income (Y) increases
- Increases (of real GDP and Y) continue until
- total production = total expenditure = total income, at this point we have macroeconomic equilibrium

Question 7

What is the definition of real consumption (C)

Answer 7

Expenditure by households on consumable items and services.
Expenditure on imported items is included

Question 8

What does consumption (C) depend on

Answer 8

-Real disposable income
-Wealth
-The average price level
-Expectations, habits

Question 9

In what way can total expenditure be divided into

Answer 9

• (C) consumption expenditure
• (I) investment
• (G) government expenditure
• (NX) net exports: exports (X) - imports (M)

total expenditure = C+I+G+(X-M)

Question 10

What is the difference between real investment and financial investment

Answer 10

• Real investment also known as capital formation.
  It is the purchase of capital goods. E.g. factories or machine (sales from production earned)
• Financial investment is a form of saving.
  Investing in a savings account or buying shares and bonds (interest)

Question 11

What are factors that influence real investment

Answer 11

• (r) real interest rates (nominal interest rate - inflation)
  -expectations
  -business confidence
  -regulations