module 16- consumption, income, and the multiplier j.a.sacco

Module 16- Consumption, Income, and the Multiplier

J.A.SACCO

2

Introduction

You have two choices when you earn income--you can either consume it or save it. What you

do not consume is, by definition, what you save.

Saving is important because investment is impossible without it. In the United States, the

rate of personal saving has dropped significantly over the past several decades.

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Did You Know That...

Personal consumption expenditures in the United States have averaged about two-thirds of gross domestic product for decades?

John Maynard Keynes focused much of his research on what determines how much you and I decide to spend

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Module 16 GOALS

Focus on what determines spending and savingConcentrate on the relationship between a persons income and how much they spend (consume) and saveAnalyze the relationship of consumption, investment, government expenditure, and net exports (GDP)In other words, what causes the changes in GDP?

C+I+G+(X-M)

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Module 16 GOALS

Why is this important to our study of economics?

?

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Some Simplifying Assumptions in the Keynesian Income Determination Model

Keynes Revisited Equilibrium level of GDP is demand determined Concentrated on elements of desired aggregate

expenditures Horizontal SRAS- Keynesian Range so inflation is

not possible/no change in price level Since PL is constant, any change in economic

variables such as income, will be equal to a real change in terms in purchasing power

Hence-Examine Keynes ideas with inflexible prices

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Definitions and Relationships

Definitions & Relationships Revisited Consumption

Spending on new goods and services out of a household’s current income

Saving The act of not consuming all of one’s income

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Definitions and Relationships

Consume It!• Gone forever• Consumption goods

(household purchases for immediate satisfaction—food, clothing, movies, etc…)

Save It!• Able to consume at a

future time and perhaps more with interest

Two things you can do with income:

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Definitions and Relationships

Consumption + Saving= Disposable Income

OR

Saving= Disposable Income-Consumption

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Definitions and Relationships

Dissaving- Negative saving. A situation where spending exceeds income.Investment-The spending by business on things which can be used to produce goods and services in the future.Stocks/Flows-A stock is a variable measured at a point in time. A flow is a variable measured over a period of time.

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Stocks and Flows

Which is a stock? Which is a flow?SavingSavingsConsumption Investment

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Stocks and Flows

Saving- (FLOW)- particular rate-daily monthly, yearly

Savings- (STOCK)- certain point in time saving+saving+saving=savings Consumption-(Flow)- related to saving, consume at

a certain rate Investment-(Flow)- expenditures by firms on new

machinery/equipment-yield future stream of income- “fixed investment”

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Classical Economic View of Consumption and Saving

Saving is based on the interest rate!

Interest rate increases

Saving increase Consumption decrease

Interest rate decreases

Saving decreases Consumption increases

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Determinants of Planned Consumption and Planned Saving

Keynes Says NO!!!• Interest rate not the key to what determines

an individuals consumption and saving decisions.

• Keynes argued that saving and consumption decisions depend primarily on an individual’s real current income.

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Determinants of Planned Consumption and Planned Saving

Keynes was concerned with changes in AD.

X G I C AD

If we can determine the reasons and tendencies of consumption and saving, it might be possible to determine the future macroeconomy.

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Real Consumption and Saving Schedules: A Hypothetical Case

(1) (2) (3) (4) (5) (6) (7)Planned Average Average

Real Planned Real Saving Propensity Propensity Marginal MarginalDisposal Real Con- Per Year to Consume to Save Propensity Propensity

Income per sumption (S=Yd-C) (APC=C/Yd) (APS=S/Yd) to Consume to SaveCombination Year (Yd) per year (C) (1) - (2) (2)/(1) (3)/(1) )dYC/(MPC )dYS/(MPS

A $0B 2,000C 4,000D 6,000E 8,000F 10,000G 12,000H 14,000I 16,000J 18,000K 20,000

$2,000 3,6005,2006,8008,40010,00011,60013,20014,80016,40018,000

$-2,000-1,600-1,200

-800-400

0400800

1,2001,6002,000

----1.81.31.1331.051.0

.967

.943

.925

.911

.9

-----.8-.30.133-.05.0.033.057.075.089.1

----.8.8.8.8.8.8.8.8.8.8

----.2.2.2.2.2.2.2.2.2.2

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The Consumptionand Saving Functions

Real Disposable Income (Yd dollars per year)

Pla

nn

ed R

eal C

on

sum

pti

on

(C, d

olla

rs p

er y

ear)

0

2,000

4,000

8,000

12,000

16,000

20,000

4,000 8,000 12,000 16,000 20,000

Consumptionfunction

A

B

C

D

E

F G

H

I

J

K

C=Yd

450

Saving

Autonomousconsumption

Break-evenincome

Dissaving

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Determinants of Planned Consumption and Planned Saving

Causes of Shifts in the Consumption Function. Non-income determinants of consumption.

Population- Increase consumption function upward.

Expectations- Better times upward/worse times downward.

Wealth- Increase real household wealth upward/decrease downward.

Can you think of other non-income determinants of consumption?

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Determinants of Planned Consumption and Planned Saving

Household Debt- Can increase consumption with borrowing or more debt. However as accumulate more debt, need to use more disposable income to pat off debt thus decreasing consumption.Inflation- Inflation down/upward, inflation up/downward.Taxes/Transfer Payments- more taxes C and S down/ less taxes C and S up. More transfer payments both C and S up, less C and S down.

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C2

The Consumptionand Saving Functions

Real Disposable Income (Yd dollars per year)

Pla

nn

ed R

eal C

on

sum

pti

on

(C, d

olla

rs p

er y

ear)

45o

C1

Assume positiveeconomic expectationsC1

Y1 Y2

C2

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C2

C2

Y2

C1

The Consumptionand Saving Functions

Real Disposable Income (Yd dollars per year)

Pla

nn

ed R

eal C

on

sum

pti

on

(C, d

olla

rs p

er y

ear)

45o

C1

Y1

Assume wealthdecreases

Y2

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The Consumptionand Saving Functions

Therefore an upward shift in consumption tells us that at all levels of disposable income, consumption is greater. If consumption is greater at all levels of disposable income, saving must be lower., and vice-versa. The only exception is taxes and transfer payments.