2/20/2010
Learning Objectives
Chapter 5
In this chapter we will introduce ten economic
concepts:
v
The Household-Consumption Sector
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
The average propensity to consume.
The average propensity to save.
The marginal propensity to consume.
The marginal propensity to save.
The consumption function.
The saving function.
The determinants of consumption.
The permanent income hypothesis.
Autonomous and induced consumption.
Why we spend so much and save so little.
GDP and Big Numbers
v
Gross Domestic Product (GDP) is the nation’s
expenditures on all final goods and services produced
during the year at market prices.
•
•
GDP for 2002 was 10,446.2 billion dollars.
This can be written as
•
•
•
$10,442,020,000,000
$10,446.2 billion
$10.5 trillion
Four Parts of GDP
v
Consumption ------------ C (this chapter)
v
Investment ---------------- I (Chapter 6)
v
Government -------------- G (Chapter 7)
v
Net exports --------------- Xn (Chapter 8)
Consumption
v
Americans spend over 95% of their income after taxes.
•
The total of everyone’s expenditures is called consumption.
•
Consumption is designated by the letter C.
Consumption (continued)
v
The consumption functions states that
•
•
As income rises, consumption (C) rises, but not as quickly.
Therefore, consumption varies with disposable income (DI).
•
v
C is the largest sector of GDP.
•
•
DI increases . . . C increases but by a smaller amount.
DI decreases . . . C decreases but by a smaller amount.
Now C is just over two-thirds of GDP.
1
2/20/2010
Consumption and Disposable Income
Consumption and Disposable Income
Disposable Income
Consumption
1,000
1,400
Disposable Income
Consumption
2,000
2,200
1,000
1,400
3,000
3,000
2,000
4,000
3,800
3,000
5,000
4,600
4,000
+ 1000
+ 800
2,200
+ 1000
+ 800
3,000
+ 1000
+ 800
3,800
+ 1000
+ 800
5,000
Questions for Thought and Discussion
4,600
Saving
v
How is it possible to consume more than your income?
v
Saving is NOT spending.
v
What sort of economy would have to develop to make
consumption a lesser part of GDP than investment,
government spending, and exports?
v
The more we spend, the less we save.
v
A low savings rate leads to a low productivity growth
rate.
•
v
Saving as a Percentage of Disposable Income
Without savings ($) to invest in NEW plant and equipment,
we cannot raise our productivity fast enough!
Savings includes personal saving, business saving,
and a government surplus (if they have one).
Average Propensity to Consume (APC)
(The Percent of DI Spent)
Consumption
APC =
Disposable Income
Source: Economic Report of the President, 2008, Survey of Current Business, March 2008
2
2/20/2010
APC, APS, MPC, and MPS values and their
meaning
v
v
v
v
v
The APC or MPC may = 1 signifying all disposable
income is consumed.
The APC or MPC may be > 1 signifying you are
consuming more than your disposable income by
dipping into your savings.
The APC or MPC may be < 1 indicating you’re a saving
a portion of your disposable income.
APC + APS = 1
MPC + MPS = 1
Sample APC Problem
Disposable Income
Consumption Saving
$40,000
$30,000
Sample APC Problem
Sample APC Problem
Disposable Income
Consumption Saving
Disposable Income
Consumption Saving
$40,000
$30,000
$40,000
$30,000
APC =
C
=
DI
30000
$10,000
3
=
40000
4
= .75
Sample APC Problem
APC =
C
DI
APS =
S
DI
30000
= 40000
=
3
= .75
4
10000
40000
=
1
= .25
4
=
APCs Greater Than One
Disposable Income
Consumption Saving
$40,000
$30,000
$10,000
Disposable Income
APC =
C
DI
= 40000
30000
S
DI
10000
40000
$10,000
=
3
4
=
1
4
= .75
$10,000
Consumption
Saving
$12,000
+
APS =
=
= .25
1.0
3
2/20/2010
APCs Greater Than One
APCs Greater Than One
Disposable Income
Disposable Income
Consumption
$10,000
$12,000
Saving
Consumption
Saving
$12,000
– 2000
$10,000
– 2000
C
APC = DI
$12,000
12
= $10,000 =
10
= 1.2
Where is this going to come from?
APCs Greater Than One
Disposable Income
Consumption
$10,000
APC =
APS =
–0.2
C
DI
S
DI
APCs Greater Than One
$12,000
$12,000
-$2,000
$10,000
– 2000
-2
=
10
=
Consumption
Saving
$12,000
– 2000
$10,000
APC = DI
Questions for Thought and Discussion
v
Disposable Income
C
12
10 = 1.2
= $10,000 =
=
Saving
APS =
$12,000
=
$10,000
12
=
10
= 1.2
S
-$2,000
-2
+
DI
= $10,000
= 10
= –0.2
1.0
Household Saving as a Percentage of Disposable
Income, 2008 Forecast
What is the relationship between the average
propensity to consume and the average propensity to
save?
•
What happens if APC is greater than 1?
Source: OECD, The Economist,
Economist Feb. 4, 2006, p. 93
4
2/20/2010
Marginal Propensity to Consume (MPC)
Average Propensity to Consume,
Selected Countries, 2008 Forecast
CHANGE in Consumption
MPC
=
CHANGE in Income
Source: OECD
Can You Calculate Marginal Propensity
to Consume (MPC) and Marginal Propensity to
Save (MPS)?
Calculating MPC
Change in income
40,000 – 30,000 = $10,000
Change in consumption
31,000 – 23,000 = $8,000
1998 and 1999 Data
Year
DI
C
S
1998
$30000
$23000
$7000
1999
$40000
$31000
$9000
Change in Consumption divided by Change in income
8,000/10,000 = .8.
Indicating your MPC is .8 or eighty% of disposable
income.
Calculating MPS
Change in Disposable Income
40,000 - 30,000 = $10,000
Change in Savings
9,000 – 7,000 = $2,000
Graphing the Consumption Function: The 45Degree Line
Aggregate
expenditures
Equilibrium
(trillions of $)
(AE = GDP)
10.0
Change in Savings divided by Disposable Income
2,000/10,000 = .2
MPS = .2 or you save 20% of Disposable Income
5.0
45º
5.0
10.0
Output
(Real GDP -trillions of $)
5
2/20/2010
Graphing the Consumption Function: The 45Degree Line (Continued)
Aggregate
expenditures
Graphing the Consumption Function
Planned consumption
Equilibrium
(trillions of $)
(trillions of $)
(AE = GDP)
45º line
12
Saving
10.0
C
9
Dis-saving
5.0
6
45º
v
3
Output
5.0
If all disposable income
was consumed, it would
be graphed as a 45degree line
10.0
(Real GDP -trillions of $)
45º
vThe
45-degree line is also
the series of points where
GDP is equal to aggregate
expenditures
3
v
v
v
Consumption is the vertical
Planned consumption
distance between the
(trillions of $)
bottom (horizontal) axis and 12
the “C” line.
If GDP is 0 Consumption is 9
$3 trillion (consumers go into
Dis-saving
savings).
6
If GDP is $6 trillion,
3
consumption will be $6
trillion.
45º
If GDP is $12 trillion
3
consumption is $9 trillion
(consumers save more than
they consume).
9
12
Real disposable
income
(trillions of dollars)
Autonomous Consumption vs. Induced
Consumption
The Consumption Function and Equilibrium
v
6
v
45º line
Autonomous consumption (AC) is the level of
consumption when disposable income is “0”.
•
Saving
It is called autonomous because it is independent of change in
disposable income.
C
v
Induced consumption (IC) is that part of consumption
that varies with the level of disposable income.
•
•
6
9
12
Real disposable
income
(trillions of dollars)
Questions for Thought and Discussion
v
What does the 45-degree line represent? Discuss the
important features of the consumption function in
relation to this line.
v
If you know the MPC can you calculate the MPS?
v
As disposable income rises, induced income rises.
As disposable income fall, induced income falls.
IC = C – AC
Consumer Spending, 1955 and 2007 ($billions)
The major change in consumer spending has been a
massive shift from nondurables to services.
Source: Economic Report of the President, 2006.
6
2/20/2010
Expenditures of the Average American
Household, 2005 Bureau of Labor Statistics
Determinants of the Level of Consumption
v
Disposable Income
v
Credit Availability
Stock of Liquid Assets (in the hands of consumers)
Stock of Durable Goods (in the hands of consumers)
Keeping up with the Jones's
Consumer Expectations
•
v
v
v
v
The most important determinant of consumption.
Source: www.bea.gov
Permanent Income Hypothesis
The Determinants of Saving
(Milton Friedman)
v
People gear their consumption to their expected
lifetime average earnings more than to their current
income.
•
Apparently there are quite a few deviations from the behavior
predicted by the permanent income hypothesis.
v
v
v
v
v
There is no single reason why people save.
Some spend virtually all of their disposable income.
Some spend more than they earn.
Americans now save less than 5% of disposable
income.
Americans used to save 7–10% of disposable income.
Why Do We Spend So Much and Save So
Little?
Savings as Percentage of GDP, 1959-2007
v
Americans have been on a spending binge for the last
20 years
•
Mottos:
•
Buy now, pay later.
Shop till you drop.
•
We want it all, and we want it all now!
•
Source: Survey of Current Business, January 2008.
7
2/20/2010
Why Do We Spend So Much and Save So Little?
(Continued)
v
The Federal Government has underwritten America’s
spending binge.
•
v
Until 1987 interest paid on consumer loans was fully
deductible from income taxes.
•
•
Why Do We Spend So Much and Save So Little?
(Continued)
Mortgage interest and property taxes remain fully deductible.
Every economy depends on saving for capital
formation.
Individual saving + business saving + government
saving = Total Saving
•
Social Security causes many to NOT feel a pressing need to
save for their old age.
•
Home ownership is seen as a form of saving (especially during
a period of rising real estate prices).
1990–2000 household debt doubled to $7 trillion.
Current Issue: The American Consumer:
World Class Shopper
Total Saving
v
•
Credit cards, installment credit, and consumer loans have
expanded tremendously.
•
v
Two factors have become increasingly important:
Declines in household saving has been offset somewhat since
1993 by a sharp rise in government saving and business
saving.
v
The consumer is the prime mover of our economy and
increasingly, that of the world economy as well.
v
The American consumer made the Japanese recovery
possible.
v
The American consumer has made China’s economic
growth of about 10% over the last 20 years possible.
v
The negative aspect of this is our tremendous trade
deficits with much of the rest of the world.
Questions for Thought and Discussion
v
What motivates consumption and what do Americans
spend their money on?
v
How realistic is Milton Friedman’s Permanent Income
Hypothesis?
v
How have American savings rates changed overtime?
What would be the consequences of present trends
continuing?
8