lec-10b & 11 - ch 12 - consumption, real gdp and multiplier - miller edited.ppt

Chapter 12

Consumption, Real GDP, and the Multiplier

Copyright ©2014 Pearson Education, Inc. All rights reserved. 12-2

Did You Know That ...

• The share of real GDP allocated to real consumption spending is:– 66 percent in Germany– 60 percent in the United Kingdom– 70 percent in the United States– Less than 41 percent in China?

• In this chapter, you will learn how an understanding of households’ real saving and real consumption spending can help you evaluate fluctuations in a national’s real GDP.


Some Simplifying Assumptions in a Keynesian Model

• To simplify the income determination model, let’s assume:

1. Businesses pay no indirect taxes (sales tax)

2. Businesses distribute all profits to shareholders

3. There is no depreciation

4. The economy is closed; no foreign trade


Some Simplifying Assumptions in a Keynesian Model (cont'd)

• Real Disposable Income– Real GDP minus net taxes, or after-tax real

income

• Consumption– Spending on new goods and services out of a

household’s current income

– Whatever is not consumed is saved

– Consumption includes such things as buying food and going to a concert



• Saving

– The act of not consuming all of one’s current income

– Whatever is not consumed out of spendable income is, by definition, saved

– Saving is an action measured over time (a flow)

– Savings are a stock, an accumulation resulting from the act of saving in the past



• Consumption Goods

– Goods bought by households to use up, such as food and movies



• Accounting identity:

Consumption + saving disposable income

Saving disposable income – consumption



• Investment

– Spending by businesses on things such as machines and buildings, which can be used to produce goods and services in the future

– The investment part of real GDP is the portion that will be used in the process of producing goods in the future



• Capital Goods

– Producer durables; nonconsumable goods that firms use to make other goods


Determinants of Planned Consumption and Planned Saving

• In the classical model, the supply of saving was determined by the rate of interest

– The higher the rate, the more people wanted to save, and the less they wanted to consume


Determinants of Planned Consumption and Planned Saving (cont'd)

• Keynes argued that: – The interest rate is not the most important factor

in saving and consumption decisions– Rather, real saving and consumption decisions

depend primarily on a household’s real disposable income.

– Furthermore, a person’s anticipation about future flows of income influences how much of current income is allocated to consumption and how much is allocated to saving.



• The Keynesian Theory of Consumption and Saving– Keynes argued that real consumption and saving

decisions depend primarily on a household’s current real disposable income.



• Consumption Function

– The relationship between amount consumed and disposable income

– A consumption function tells us how much people plan to consume at various levels of disposable income



• Dissaving

– Negative saving; a situation in which spending exceeds income

– Dissaving can occur when a household is able to borrow or use up existing assets


Table 12-1 Real Consumption and Saving Schedules: A Hypothetical Case



• 45-Degree Reference Line

– The line along which planned real expenditures equal real GDP per year


Figure 12-1 The Consumption and Saving Functions



• Autonomous Consumption

– The part of consumption that is independent of the level of disposable income

– Changes in autonomous consumption shift the consumption function



• Average Propensity to Consume (APC)

– Real consumption divided by real disposable income

– The proportion of total disposable income that is consumed

APC =Real consumption

Real disposable income



• Average Propensity to Save (APS)

– Real saving divided by real disposable income (DI)

– Saved proportion of real DI

APS =Real saving

Real disposable income


MPC =Change in real consumption

Change in real disposable income


• Marginal Propensity to Consume (MPC)

– The ratio of the change in real consumption to the change in real disposable income


MPS =Change in real saving

Change in real disposable income


• Marginal Propensity to Save (MPS)

– The ratio of the change in saving to the change in disposable income


APC =$49,200

$54,000= .911


• Example– Income = $54,000

– C = $49,200

– S = $4,800

• What is the APC?


APC =$54,000

$60,000= .90


• Example– Income increases by $6,000 to $60,000

– C = $54,000

– S = $6,000

• What is the APC?



• Some relationships

APC + APS 1

MPC + MPS 1



• Causes of shifts in the consumption function

– A change besides real disposable income will cause the consumption function to shift

– Non-income determinants of consumption• Population

• Wealth


Determinants of Investment

• Investment, you will remember, consists of expenditures on new buildings and equipment

– Gross private domestic investment has been volatile

– Consider the planned investment function, and shifts in the function


Figure 12-2 Planned Real Investment, Panel (a)


Figure 12-2 Planned Real Investment, Panel (b)


Determining Equilibrium Real GDP

• We are interested in determining the equilibrium level of real GDP per year

– Consumption as a function of real GDP

– The 45-degree reference line


Figure 12-3 Consumption as a Function of Real GDP


Determining Equilibrium Real GDP (cont'd)

• Adding the investment function

AD = C + I + G + X


Figure 12-4 Combining Consumption and Investment



• Saving and investment: Planned versus Actual

– Only at equilibrium real GDP will planned saving equal actual saving

– Planned investment equals actual investment

– Hence planned saving is equal to planned investment


Figure 12-5 Planned and Actual Rates of Saving and Investment



• Unplanned increases in business inventories

– Consumers purchase fewer goods and services than anticipated

– This leaves firms with unsold products and inventories will rise

– Businesses respond by cutting back production and reducing employment



• Unplanned decreases in business inventories

– Business will increase production of goods and services and increase employment

– Ultimately there will be an increase in real GDP


Keynesian Equilibrium with Government and the Foreign Sector Added

• To this point we have ignored the role of government in our model

• We also left out the foreign sector of the economy in our model

• Let’s think about what happens when we add these elements


Keynesian Equilibrium with Government and the Foreign Sector Added (cont'd)

• Government (G): C + I + G– Federal, state, and local

• Does not include transfer payments• Is autonomous• Lump-sum taxes = G

• Lump-Sum Tax– A tax that does not depend on income or the

circumstances of the taxpayer



• The Foreign Sector: C + I + G + X

– Net exports (X) equals exports minus imports

– Depends on international economic conditions

– Autonomous—independent of real national income


Table 12-2 The Determination of Equilibrium Real GDP with Government and Net Exports Added



• Determining the equilibrium level of GDP per year

– We are now in a position to determine the equilibrium level of real GDP per year

– Remember that equilibrium always occurs when total planned real expenditures equal real GDP


Figure 12-6 The Equilibrium Level of Real GDP



The Equilibrium Level of Real GDP• Observations

– If C + I + G + X = Y • Equilibrium GDP

– If C + I + G + X > Y • Unplanned decrease in inventories• Businesses raise output• Y returns to equilibrium

– If C + I + G + X < Y• Unplanned increase in inventories• Businesses reduce output• Y returns to equilibrium


The Multiplier

• Multiplier

– The ratio of the change in the equilibrium level of real national income to the change in autonomous expenditures

– The number by which a change in autonomous real investment or autonomous real consumption is multiplied to get the change in equilibrium real GDP


The Multiplier (cont'd)

• Question– How can a $100 billion increase in investment

generate a $500 billion increase in equilibrium real GDP?

• Answer– The multiplier process


Table 12-3 The Multiplier Process



• The multiplier formula

Multiplier = 11 - MPC

= 1MPS



• By taking a few numerical examples, you can demonstrate to yourself an important property of the multiplier

– The smaller the MPS, the larger the multiplier

– The larger the MPC, the larger the multiplier



• Examples

MPC =45

MPS =15

Multiplier =1

1/5= 5

MPC =35

MPS =25

Multiplier =1

2/5= 2.5


Change in equilibrium real GDP = Multiplier x Change in autonomous spending


• Measuring the change in equilibrium income from a change in autonomous spending



• Significance of the multiplier

– It is possible that a relatively small change in consumption or investment can trigger a much larger change in real GDP


Figure 12-7 Effect of a Rise in Autonomous Spending on Equilibrium Real GDP


Figure C-1 Graphing the Multiplier

lec-10b & 11 - ch 12 - consumption, real gdp and multiplier - miller edited.ppt

Documents