Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Key Terms
8
Basic
Macroeconomic
Relationships
End Show
8-1
Copyright 2008 The McGraw-Hill Companies
Chapter Objectives
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Key Terms
End Show
8-2
• How Changes in Income Affect
Consumption (and Saving)
• About Factors Other Than
Income That Can Affect
Consumption
• How Changes in Real Interest
Rates Affect Investment
• About Factors Other Than the
Real Interest Rate That Can
Affect Investment
• Why Changes in Investment
Increase or Decrease Real GDP
by a Multiple Amount
Copyright 2008 The McGraw-Hill Companies
Basic Relationships
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
• Income-Consumption
• Income-Saving
• 45° Line
• C = DI on the Line
• S = DI - C
Key Terms
End Show
8-3
Copyright 2008 The McGraw-Hill Companies
Income and Consumption
Consumption and Disposable Income, 1983-2005
Key Terms
10000
9000
Consumption (billions of dollars)
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
8000
04
03
01
7000
02
00
C
99
6000
Saving
In 1992
5000
4000
3000
83
2000
84
98
97
96
95
94
93
92
91
90
89
88
87
86
85
Consumption
In 1992
1000
45°
0
0
End Show
05
45° Reference Line
C=DI
2000
4000
6000
8000
Disposable Income (billions of dollars)
8-4
Copyright 2008 The McGraw-Hill Companies
10000
Consumption and Saving
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
• The Consumption
Schedule
• The Saving Schedule
• Break-Even Income
• Average Propensity to
Consume (APC)
• Average Propensity to
Save (APS)
Consumption
APC =
Income
Key Terms
End Show
8-5
Copyright 2008 The McGraw-Hill Companies
APS =
Saving
Income
O 8.1
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Consumption and Saving
• Marginal Propensity to
Consume (MPC)
• Marginal Propensity to
Save (MPS)
Change in Consumption
MPC =
Change in Income
Change in Saving
MPS = Change in Income
Key Terms
End Show
8-6
Copyright 2008 The McGraw-Hill Companies
Consumption and Saving
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Key Terms
(1)
Level of
(2)
Output
ConsumpAnd
tion
Income
(C)
(GDP=DI)
(1) $370
(4)
(5)
(6)
(7)
Average
Average
Marginal
Marginal
Propensity Propensity Propensity Propensity
(3)
to Consume to Save
to Consume to Save
Saving (S)
(APC)
(APS)
(MPC)
(MPS)
(1-2)
(2)/(1)
(3)/(1)
Δ(2)/Δ(1)
Δ(3)/Δ(1)
$375
$-5
1.01
-.01
(2)
390
390
0
1.00
.00
(3)
410
405
5
.99
.01
(4)
430
420
10
.98
.02
(5)
450
435
15
.97
.03
(6)
470
450
20
.96
.04
(7)
490
465
25
.95
.05
(8)
510
480
30
.94
.06
(9)
530
495
35
.93
.07
(10) 550
510
40
.93
.07
End Show
8-7
Copyright 2008 The McGraw-Hill Companies
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
Consumption and Saving
Key Terms
End Show
8-8
500
C
475
450
425
Saving $5 Billion
Consumption
Schedule
400
375
Dissaving $5 Billion
45°
Saving
(billions of dollars)
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Consumption (billions of dollars)
Consumption and Saving Schedules
370 390 410 430 450 470 490 510 530 550
Disposable Income (billions of dollars)
50
Dissaving
Saving Schedule
S
25 $5 Billion
Saving $5 Billion
0
370 390 410 430 450 470 490 510 530 550
Copyright 2008 The McGraw-Hill Companies
Consumption and Saving
GLOBAL PERSPECTIVE
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Average Propensities to Consume
Select Nations GDPs
Average Propensities to Consume
.80
.85
.90
.95
1.00
United States
.963
Canada
.958
United Kingdom
.953
Japan
.942
Germany
.896
Netherlands
.893
Italy
Key Terms
France
.840
.833
End Show
Source: Statistical Abstract of the United States, 2006
8-9
Copyright 2008 The McGraw-Hill Companies
Consumption and Saving
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Key Terms
End Show
8-10
• MPC + MPS = 1
• MPC and MPS as Slopes
• Nonincome Determinants
of Consumption and
Saving
–Wealth Effect
–Expectations
–Real Interest Rates
–Household Debt
Copyright 2008 The McGraw-Hill Companies
W 8.1
Consumption and Saving
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
• Other Important
Considerations
• Changes Along Schedules
• Switch to Real GDP
• Schedule Shifts
• Stability
Key Terms
• Taxation
End Show
8-11
Copyright 2008 The McGraw-Hill Companies
G 8.1
Consumption and Saving
Consumption and Saving Schedules
Key Terms
End Show
8-12
C0
C2
45°
Saving
(billions of dollars)
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Consumption (billions of dollars)
C1
Disposable Income (billions of dollars)
Copyright 2008 The McGraw-Hill Companies
S2
S0
S1
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Interest Rate and Investment
• Expected Rate of Return (r)
• The Real Interest Rate (i)
• Meaning of r = i
• Investment Demand Curve
O 8.2
G 8.2
Key Terms
End Show
8-13
Copyright 2008 The McGraw-Hill Companies
Interest Rate and Investment
The Investment Demand Curve
Cumulative
Amount of
Investment
Having This
Rate of
Expected
Return or Higher
Rate of
(i)
Return (r)
16%
14%
12%
10%
8%
6%
4%
2%
0%
$ 0
5
10
15
20
25
30
35
40
Key Terms
16
14
r and i (percent)
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
12
10
8
6
4
ID
2
0
5
10
15
20
25
30
35
Investment (billions of dollars)
End Show
8-14
Copyright 2008 The McGraw-Hill Companies
40
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Key Terms
End Show
8-15
Interest Rate and Investment
• Shifts of the Investment
Demand Curve
–Acquisition, Maintenance,
and Operating Costs
–Business Taxes
–Technological Change
–Stock of Capital Goods on
Hand
–Expectations
Copyright 2008 The McGraw-Hill Companies
Interest Rate and Investment
Key Terms
Increase in
Investment Demand
r and i (percent)
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Shifts in the Investment
Demand Curve
Decrease in
Investment Demand
0
Investment (billions of dollars)
End Show
8-16
Copyright 2008 The McGraw-Hill Companies
ID2 ID0
ID1
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Interest Rate and Investment
• Instability of Investment
–Durability
–Irregularity of Innovation
–Variability of Profits
–Variability of Expectations
Key Terms
End Show
8-17
Copyright 2008 The McGraw-Hill Companies
Interest Rate and Investment
GLOBAL PERSPECTIVE
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Gross Investment Expenditures as a
Percent of GDP, Select Nations
Percent of GDP, 2004
0
10
20
30
South Korea
Japan
Mexico
Canada
France
United States
Germany
Key Terms
United Kingdom
End Show
Sweden
Source: World Bank
8-18
Copyright 2008 The McGraw-Hill Companies
Interest Rate and Investment
The Volatility of Investment
40
30
Percentage Change
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
20
Gross Investment
10
0
GDP
-10
-20
-30
1971 1975
Key Terms
1979
1983
1987 1991
Year
End Show
8-19
Copyright 2008 The McGraw-Hill Companies
1995
1999
2003
The Multiplier Effect
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Multiplier =
Change in Real GDP
Initial Change in Spending
The Multiplier and the Marginal Propensities
Multiplier =
1
1 - MPC
-orMultiplier =
1
MPS
Key Terms
Graphically…
End Show
8-20
W 8.2
Copyright 2008 The McGraw-Hill Companies
The Multiplier Effect
Tabular and Graphical Views
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Increase in Investment of $5
Second Round
Third Round
Fourth Round
Fifth Round
All other rounds
Total
$ 20.00
$ 15.00
$ 5.00
$20.00
$4.75
15.25
13.67
11.56
8.75
5.00
$1.58
$2.11
$2.81
ΔI=
$5 billion
$3.75
Key Terms
$5.00
End Show
1
8-21
(2)
(3)
Change in
Change in
(1)
Saving
Change in Consumption
(MPC = .75) (MPC = .25)
Income
$ 5.00
$ 3.75
$ 1.25
3.75
2.81
.94
2.81
2.11
.70
2.11
1.58
.53
1.58
1.19
.39
4.75
3.56
1.19
Copyright 2008 The McGraw-Hill Companies
2
3
4
Rounds of Spending
5
All
The Multiplier Effect
The MPC and the Multiplier
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Key Terms
MPC
Multiplier
.9
10
.8
5
.75
4
.67
.5
3
2
End Show
8-22
Copyright 2008 The McGraw-Hill Companies
Squaring the Economic Circle
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Key Terms
End Show
8-23
• Humorist Art Buchwald and the
Multiplier
• One Person Can’t Buy a Product
• Others Subsequently Impacted
and Cannot Buy Other Items
• Multiple Effects Impact Psyche
• Ultimately Causes Multiple Step
Impact Upon the Economy as a
Whole
Copyright 2008 The McGraw-Hill Companies
Key Terms
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
Key Terms
• 45° (degree) line
• consumption
schedule
• saving schedule
• break-even
income
• average
propensity to
consume (APC)
• average
propensity to
save (APS)
End Show
8-24
Copyright 2008 The McGraw-Hill Companies
• marginal
propensity to
consume (MPC)
• marginal
propensity to
save (MPS)
• wealth effect
• expected rate of
return
• investment
demand curve
• multiplier
Next Chapter Preview…
Basic
Relationships
Income and
Consumption
Consumption and
Saving
Consumption and
Saving Schedules
Changes in C & S
Interest Rate and
Investment
Investment
Demand Curve
Shifts in the
Investment
Demand Curve
Volatility of
Investment
Multiplier Effect
Last Word
The Aggregate
Expenditures Model
Key Terms
End Show
8-25
Copyright 2008 The McGraw-Hill Companies