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Figure 23.3 (Macro 10) Alternative Short-Run Responses of a Typical Firm to a Change in Demand

Figure 23.3 (Macro 10) Alternative Short-Run Responses of a Typical Firm to a Change in Demand

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1. Changes in Aggregate Demand…. (cont.)

• 1d. Another explanation of economic fluctuations

is the real business cycle theory. Under this

explanation, the source of economic fluctuations is

found in frequent shifts in potential GDP. This

would mean that the determinants of aggregate

supply (labor, capital, and technology) must shift

frequently. However, these determinants tend to

change slowly over time.



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2. Forecasting Real GDP

2a. The case for viewing shifts in aggregate

demand as the source of economic fluctuations

can be seen as a forecasting problem. To forecast

real GDP, a forecast of each component is made

and then added together using the GDP identity: Y

= C + I + G + X . As the underlying factors for

each spending component change, the value in the

forecast changes.



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2. Forecasting Real GDP (cont.)

• 2b. Another approach is to make a conditional

forecast, one in which alternative assumptions

about the value of an underlying factor or the

value of one of the spending components is made.

This approach to forecasting real GDP makes clear

that it is changes in the spending components, or

aggregate demand, that are responsible for

economic fluctuations



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3. The Response of Consumption to Income

• 3a. The consumption function describes how

consumption depends on income. This relationship

is illustrated by Table 25.1. From this data we are

able to determine the marginal propensity to

consume (MPC). Figure 23.4 graphs the

consumption-income relation.



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Figure 23.4

(Macro 10)

The Consumption Function



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3. The Response of Consumption to Income

• 3a.1 The measure of income used, whether real

GDP, income, or disposable income, depends in

part on the purpose of the analysis. However,

because taxes and transfer payments tend to be a

constant proportion of income, the measures bear

essentially the same relation to consumption, as in

Figure 23.5.



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Figure 23.3 (Macro 10) Alternative Short-Run Responses of a Typical Firm to a Change in Demand

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