Slide Show #4
AGEC 430
Macroeconomics of Agriculture
Spring 2010
Handout #4
GDP = C + I + G + X – M
where:
Consumption represents
70% of GDP
C = consumption expenditures
I = investment expenditures
G = government expenditures
X = exports
M = imports
Annual level of personal consumption expenditures. Represents 70
percent of our nation’s GDP.
Annual percent change in personal consumption expenditures. This graph
highlights the recent downturn in C relative to recent recessions.
The simple consumption function originally formulated by Keynes back
in the late 1930s.
Quarterly level of disposable personal income. The is the Y – T variable in
the consumption function on the previous page.
The slope of the consumption
function is known as the marginal
propensity to consume.
Personal saving rate.
∆C / ∆(Y – T)
Real wealth effect can be
inflationary as we saw in 1990s.
What about recent years?
Why is this concept important?
A one-time spike in disposable income or “transitory income” will do little
to change consumption behavior since it is not expected to continue.
Peak earnings
Savings rate low
Age 25
Savings rate rising
Age 45
Age 65 = T
N – T at age 45
Lifetime Earnings Cycle
We can Graph
these
relationships
Planned Consumption Function
The consumption function
in this graph can be
expressed graphically as
shown below.
C = AC + b1(Y - T)
Planned Consumption Function
The slope of the
consumption function
is the marginal propensity
to consume (MPC), or
C / (Y – T)
Autonomous or
fixed consumption
Planned Consumption Function
Consumer expenditures
would be $3,600 if
disposable income was
equal to $3,000.
Consumers would be
dis-saving by $600.
C = $1,500 + .70($3,000) = $3,600
Planned Consumption Function
An increase in
disposable income to
$4,000 would raise
expenditures to
$4,300.
Dis-saving would
fall to $300.
C = $1,500 + .70($4,000) = $4,300
Planned Consumption Function
An increase in
disposable income to
$5,000 would raise
expenditures to
$5,000.
Dis-saving would
fall to zero.
C = $1,500 + .70($5,000) = $5,000
Planned Consumption Function
A role for fiscal
policy here:
A cut in the tax
rate increases
consumption.
An increase in the
tax rate decreases
consumption.
Planned Consumption Function
A role for fiscal
policy here:
A cut in the tax
rate increases
consumption.
An increase in the
tax rate decreases
consumption.
Real Wealth Effect
Suppose stock market
prices rose, increasing
real wealth of consumers
by $700.
Real Wealth Effect
This would increase
the intercept by $700,
Real Wealth Effect
This shifts the curve
upward for given
income level, boosts
consumer spending
to $5,000. This raises
dis-saving to $1,000,
raising debt relative to
income, and can be
inflationary…..
C = $1,500 + $700 + .70($4,000) = $5,000
Annual percent change in personal consumption expenditures.
Given our discussion thus far, what has caused consumption to
decline so sharply?