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The Consumption Schedule:What is the consumption-disposable income relationship?
higher income --- > higher consumption
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The Saving Schedule:What is the income-saving relationship?
Higher income --- > Higher saving
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Define Saving
- Disposable income not consumed
- S = DI - C
- Savings = Disposable income - consumption
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Define Disposable Income
After tax income
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Define Break-Even Income
Income level at which households consume all income and save none of it.
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Describe the Consumption/Disposable Income Schedule
- 45 degree line - consumption = disposable income
- "c" line - consumption
- Distance between 45 degree and C - savings
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Define APC
- Average Propensity to Consume:
- Fraction/percentage of income that is consumed
APC = consumption/income
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Define APS
- Average Propensity to Save
- Fraction/percentage of income that is saved
APS = saving/income
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What is the relationship between APC and APS?
APC + APS = 1
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Define MPC
- Marginal Propensity to Consume
- Fraction or percentage of the CHANGE in income that is spent
MPC = change in consumption/change in income
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Define MPS
Fraction or percentage of CHANGE in income that is saved
MPS = change in saving/change in income
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What is the relationship between MPC and MPS?
MPC + MPS = 1
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Non-Income Determinants of Consumption and Saving:
1. Wealth
- Wealth Effect:
- Shifts consumption schedule upward and the saving schedule downward
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Non-Income Determinants of Consumption and Saving:
2. Borrowing
- Temporary higher consumption
- Long run lower consumption
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Non-Income Determinants of Consumption and Saving:
3. Expectations
- a. Expectation of rising prices tomorrow = more spending and less saving today
- b. Expectation of lower income in the future = less consumption and more saving today
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Non-Income Determinants of Consumption and Saving:
4. Real Interest Rates
- a. Low Interest Rates
- Borrow more
- Consume more
- Save less
- Shifts consumption schedule slightly upward
- Shifts saving schedule slightly downward
- b. High Interest Rates
- Borrow less
- Consume less
- Save more
- Shifts consumption schedule slightly downward
- Shifts saving schedule slightly upward
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Movement from one point to another on the consumption schedule:
Is caused by a CHANGE in DISPOSABLE INCOME
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A shift of the entire consumption schedule:
- Is caused by one of the four non-income determinants of consumption and saving:
- Wealth
- Borrowing
- Expectations
- Interest Rates
These four things shift the consumption schedule and saving schedule in opposite directions
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Explain Taxation
Shifts the consumption schedule and saving schedule in the same direction
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Explain Real Interest Rate
i = nominal rate - rate of inflation
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What relationship does the Investment Demand Curve illustrate?
- Inverse relationship between the real interest rate and the quantity of investment demanded
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Explain shifts in the Investment Demand Curve
- Increases in investment demand: rightward shifts
- Decreases in investment demand: leftward shifts
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Shifts in the Investment Demand Curve
1. Aquisition, Maintenance and Operating Costs
- When costs fall, the expected rate of return rises, shifting the investment demand curve to the right
- When costs rise, the curve shifts to the left
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Shifts in the Investment Demand Curve
2. Business Taxes
- An increase in business taxes lowers the profitability of the firm, shifting the investment demand curve to the left
- A reduction of taxes shifts the curve to the right
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Shifts in the Investment Demand Curve
3. Technological Change
A rapid rate of technological progress shifts the investment demand curve to the right
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Shifts in the Investment Demand Curve
4. Stock of Capital Goods on Hand
- Excess production capacity (overstocked): curve shifts leftward
- Understocked: investment demand curve shifts rightward
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Shifts in the Investment Demand Curve
5. Planned Inventory
- Plans to increase: curve shifts right
- Plans to decrease: curve shifts left
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Shifts in the Investment Demand Curve
6. Expectation
- Positive expectations: Right
- Negative expectations: Left
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Define The Multiplier
The relationship between changes in GDP and changes in spending (expenditure)
MULTIPLIER = change in GDP / Change in Spending
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