CHAPTER 31

HOUSEHOLD AND FIRM BEHAVIOR IN

THE MACROECONOMY: A FURTHER
LOOK
Assumptions:
Household consumption (C)
depends only on income
Planned investment (I) depends
only on the interest rates

Nominal wage rate the wage rate in

current dollars
Real wage rate the amount the
nominal wage rate can buy in terms of
goods and services
Nonlabor or nonwage income any
income received from sources other than
working inheritances, interest,

Life-cycle theory of consumption a

theory of household consumption:
Households make lifetime consumption
decision based on their expectations of
lifetime income

dividends, transfer payments

^differs from Keynesian Theory

current income determines current
consumption

Transfer payments payments such as

Social Security benefits, veterans
benefits, and welfare benefits

Permanent income the average level

of a persons expected future income
stream

The Labor Supply Decision

Effects in wage rate increase:
a. Substitution effect higher wage
would lead to a larger quantity of
labor supplied
- people will work more when wage
rate rises
b. Income effect people with higher
income will spend some of it on leisure
by working less
- people will work less when wage
rate rises

Interest rate effects on

consumption:
a. Substitution effect a rise in the
interest rate leads you to consume less
today and save more
b. Income effect if a household has
positive wealth and is earning interest on
that wealth, a fall in the interest rate
leads to a fall in interest income

Possible Employment Constraint on

Households
Unconstrained supply of labor the
amount a household would like to work
within a given period at the current wage
rate if it could find the work

Constrained supply of labor the

amount a household actually works in a
given period at the current wage rate

Animal spirits of entrepreneurs a

term coined by Keynes to describe
investors feelings
Accelerator effect the tendency for
investment to increase when aggregate
output increases and to decrease when
aggregate output decreases, accelerating
the growth or decline of output
Excess labor, excess capital labor
and capital that are not needed to
produce the firms current level of output
Adjustment costs the costs that a
firm incurs when it changes is production
level for example, the administration

costs of laying off employees or the

training costs of hiring new workers
Inventory investment the change in
the stock of inventories
Desired, or optimal, level of
inventories - the level of inventory at
which the extra cost (in lost sales) from
lowering inventories by a small amount is
just equal to the extra gain (in interest
revenue and decreased storage costs)
Productivity or labor productivity
output per worker hour
Okuns Law in the short run the
unemployment rate decreases about 1%
point for ever 3% increase in real GDP
Discouraged-worker effect - the
decline in the measured unemployment
rate that results when people who want
to work but cannot find work grow
discouraged and stop looking, dropping
out of the ranks of the unemployed and
the labor force