Chapter 8: Basic Macroeconomic Relationships

higher income --- > higher consumption

Higher income --- > Higher saving

• Disposable income not consumed
• S = DI - C
• Savings = Disposable income - consumption

After tax income

Income level at which households consume all income and save none of it.

• 45 degree line - consumption = disposable income
• "c" line - consumption
• Distance between 45 degree and C - savings

• Average Propensity to Consume:
• Fraction/percentage of income that is consumed

APC = consumption/income

• Average Propensity to Save
• Fraction/percentage of income that is saved

APS = saving/income

APC + APS = 1

• Marginal Propensity to Consume
• Fraction or percentage of the CHANGE in income that is spent

MPC = change in consumption/change in income

Fraction or percentage of CHANGE in income that is saved

MPS = change in saving/change in income

MPC + MPS = 1

• Wealth Effect:
• Shifts consumption schedule upward and the saving schedule downward

• Temporary higher consumption
• Long run lower consumption

• 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

• 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

Is caused by a CHANGE in DISPOSABLE INCOME

• 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

Shifts the consumption schedule and saving schedule in the same direction

i = nominal rate - rate of inflation

• Inverse relationship between the real interest rate and the quantity of investment demanded
• 

• Increases in investment demand: rightward shifts
• Decreases in investment demand: leftward shifts

• 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

• 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

A rapid rate of technological progress shifts the investment demand curve to the right

• Excess production capacity (overstocked): curve shifts leftward
• Understocked: investment demand curve shifts rightward

• Plans to increase: curve shifts right
• Plans to decrease: curve shifts left

• Positive expectations: Right
• Negative expectations: Left

The relationship between changes in GDP and changes in spending (expenditure)

MULTIPLIER = change in GDP / Change in Spending