economic terms part 2

November 20, 2008 at 4:27 am (ECONOMICS) ()

GDP: The total market value of all goods and services produced within the political boundaries of an economy during a given period of time, usually one year. This is the government’s official measure of how much output our economy produces. It’s tabulated and reported by the National Income and Product Accounts maintained by the Bureau of Economic Analysis, which is part of the U. S. Department of Commerce. Gross domestic product is one of several measures reported regularly (every three months) by the pointy-headed folks at the Bureau of Economic Analysis.

GNP: The abbreviation for gross national product, which is the total market value of all goods and services produced by the citizens of an economy during a given period of time, usually one year. Gross national product, often was once the federal government’s official measure of how much output our economy produces. In the early 1990s, however, it was replaced by gross domestic product (GDP).

CONSUMPTION FUNCTION: The positive relation between household consumption expenditures and household disposable income that forms one of the key building blocks for Keynesian economics. The consumption function is commonly presented as the consumption line or propensity-to-consume line. The slope of this line is the marginal propensity to consume, which is the proportion of any additional income used for consumption. The consumption function and the marginal propensity to consume play key roles in the multiplier and accelerator concepts. Because saving is the difference between disposable income and consumption, the saving function is a complementary relation to the consumption function.

MARGINAL PROPENSITY TO SAVE:

The proportion of each additional dollar of household income that is used for saving. The marginal propensity to save (abbreviated MPS) is another term for the slope of the saving line and is calculated as the change in saving divided by the change in income. The MPS plays a central role in Keynesian economics. It quantifies the saving-income relation, which is the flip side of the consumption-income relation, and thus it reflects the fundamental psychological law. It is also a critical to the multiplier process. A related saving measure is the average propensity to save.

The marginal propensity to save (MPS) indicates what the household sector does with extra income. The MPS indicates the portion of additional income that is used for saving. If, for example, the MPS is 0.25, then 25 percent of extra income goes for saving.

Because saving is the complement of consumption, the marginal propensity to save reflects key aspects about household consumption and saving activity. This activity is critical to the macroeconomy and the study of Keynesian economics. First, the MPS captures induced saving, which is one aspect of the fundamental psychological law of consumer spending proposed by John Maynard Keynes as a key difference between his Keynesian theory and classical economics. Second, the MPS is the slope of the saving line, which makes it the foundation for Keynesian injections-leakages model. Third, the MPS affects the multiplier process and affects the magnitude of the expenditures and tax multipliers.

The MPS Formula

The standard formula for calculating marginal propensity to save (MPS) is:

MPS

=

change in saving


change in income

This formula has a couple of interpretations.

  • First, it quantifies induced saving, that is, how much of each extra dollar of income is used for saving. If income changes by $1, then saving changes by the value of the MPS. Income induces the change in saving at a rate measured by the MPS.

  • Second, the MPS is actually a measure of the slope of the saving line. The measurement of slope is generally given as the “rise” over the “run.” For the saving line, the rise is the change in saving and the run is the change in income.

MPC: The abbreviation for marginal propensity to consume, which is the proportion of each additional dollar of household income that is used for consumption expenditures. Or alternatively, this is the change in consumption expenditures due to a change in disposable income. The marginal propensity to consume is the slope of the consumption or propensity-to-consume line that forms the foundation for Keynesian economics. As such, it also takes center stage for the slope of the aggregate expenditure line and the multiplier effect. The sum of the marginal propensity to consume and the related concept, the marginal propensity to save, is equal to one.

BUSINESS CYCLE: The recurring expansions and contractions of the national economy (usually measured by real gross domestic product). A complete cycle typically lasts from three to five years, but could last ten years or more. It is divided into four phases — expansion, peak, contraction, and trough. Unemployment inevitably rises during contractions and inflation tends to worsen during expansions. To avoid the inflation and unemployment problems of business cycles, the federal government frequently undertakes various fiscal and monetary policies.

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