Aggregate Expenditure
Components
Consumption
Investment
Government
Net Exports
Composition of Aggregate Expenditure
© 2003 South-Western/Thomson Learning
1
Consumption
Stable and positive relationship
between consumption and income
Next slide shows the relationship
between disposable income and
consumption spending
2
Consumer Spending
and Disposable Income
The relationship between
disposable income and
consumption has been
relatively stable.
Trillions of 1996 Dollars
8
Saving is the difference
between disposable income
and consumption and is
shown by the vertical
distance between the two
lines.
7
6
5
saving
disposable income
4
3
2
consumption
1
0
1960 1965 1970 1975 1980 1985 1990 1995 2000
Source: based on annual estimates from Bureau of Economic Analysis, U.S. Dept of Commerce. Figures for 2001 were projected as
3
of September. For the latest data, go to http://www.bea.doc.gov/bea/dn1.htm.
Real Consumer Spending
Dependence of Consumer
Spending on Disposable Income
8
7
6
5
4
3
2
1
0
2001
1995
1986
A clear and direct
relationship between
consumption and
disposable income.
1970
0
1 2
3 4
5 6
7
Real Disposable Income
Source: based on estimates from the Bureau of Economic Analysis, U.S. Dept of Commerce. Point for 2001 was projected as of
September. For the latest data, go to http://www.bea.doc.gov/bea/dn1.htm.
4
Consumption Function
Consumption is a function of income
Consumption: dependent variable
Disposable income: independent variable
Next slide presents a hypothetical
consumption function:
Positive relationship between the level of
disposable income and the amount spent on
consumption, with other determinants of
consumption assumed to be constant
5
Real Consumption
(trillions of dollars)
The Consumption Function
10
9
8
7
6
5
4
3
2
1
0
1
2
3
4
5
6
7
8
Real Disposable Income
(trillions of dollars)
9
Both disposable income and consumption are measured
in real terms, or in inflation-adjusted dollars .
6
Marginal Propensities to Consume and Save
What happens to consumption and
saving when income changes?
Marginal Propensity to Consume (MPC)
• change in consumption divided by the change in
income
Marginal Propensity to Save (MPS)
• change in saving divided by the change in income
MPC + MPS = 1
All disposable income are spent on
consumption or saved
7
Horizontal-axis: Change
in disposable income
Vertical axis: Change in
consumption
C o n s u m p tio n
(trillio n s o f d o lla rs )
Marginal Propensity to Consume
b
∆C = 0.4
a
∆DI = 0.5
∆C 0.4 4
MPC = ∆DI = 0.5 = 5
Slope = MPC
0
MPC=0.8 or 80% Î 80% of any change in income is
spent on consumption
Real disposable income
(trillions of dollars)
8
Marginal Propensity to Save
Saving
(trillions of dollars)
Slope= MPS Î
Ex: Saving will change by 20% of every dollar
change in income.
∆S
0.1
1
MPS = ∆DI =
=
0.5
5
c
d
∆S = 0.1
∆DI = 0.5
0
Real disposable income
(trillions of dollars)
9
Shifts and Movements Along
Movement along the consumption
function results from a change in
income
Shift of the consumption function
results from a change in one of the
nonincome determinants of
consumption
10
Nonincome Determinants
What could cause the consumption
function to shift?
Net Wealth
Price Level
Interest Rate
Expectations
11
Net Wealth
Net wealth:
the value of all assets minus any liabilities
or debts
A decrease in net wealth
make consumers less inclined to spend –
more inclined to save
Increase in net wealth Î
Increases consumption
consumption function shift from C to C”
12
Shifts in the Consumption Function
C"
Increase in net
wealth: CÆ C"
C'
Real Consumption
Decrease in net
wealth: C Æ C'
C
0
Real disposable income
13
Price Level
Some household wealth is held in
dollar-denominated assets such as bank
accounts and cash
If price level changes, the real value of
dollar-denominated assets changes
Increase in the price level reduces the
purchasing power of wealth held in fixed
dollar assets ÎConsume less and save more
Decreases in the price level increase the
purchasing power of wealth held in fixed
assets Î Consume more and save less
14
Interest Rate
Interest
The reward savers earn for deferring
consumption
the cost paid by borrowers for current
spending power
The higher the interest rate,
the less is spent on purchased on credit
Save more and borrow less
Consumption function shifts downward
A lower interest rate shifts the
consumption function upward
15
Expectations
Expectations about
price levels,
interest rates,
job security and etc.
influence economic behavior in a variety
of ways
If expectations become more pessimistic
Consumption function shifts downward
If expectations become more optimistic
Consumption function shifts upward
16
Aggregate Expenditure
Components
Consumption
Investment
Government
Net Exports
Composition of Aggregate Expenditure
© 2003 South-Western/Thomson Learning
17
Investment
Investment consists of spending
on
New factories
New equipment
New housing
Net change in inventories
expectation of a future return
Investors must estimate how much
a investment will yield in all years
of its productive life
18
Investment
Buy new capital goods if expecting this
investment yield a greater return than other
possible uses of funds
The expected rate of return =
annual dollar earnings / purchase price
The example in next slide provides us with a
comparison between
the rates of return
market interest rate
19
Rate of Return on Golf Carts
and the Opportunity Cost of Funds
Nominal Interest Rate (percent)
Each cart costs $2,000
25
The first cart is expected to rent $400/year.
Expected rate of return= 20% (=$400 / $2,000)
20
15
Expected rate
of return
10
8
5
0
The second
cart
generates
$300/ year Î
Market rate a rate of
of interest return of
$300 / $2,000
= 15%,
$2,000 $4,000 $6,000 $8,000 $10,000
Investment
20
Investment
Should the firm invest in golf carts, and
if so, how many?
If the firm borrows the money to buy
the carts
The number of carts depends on the interest
rate they pay to borrow the money
Let market interest rate= 8%
profit is maximized if $6,000 is invested in
the carts (10%>8%)
Purchase three carts
The market interest rate is the
opportunity cost of investing in capital
21
From Micro to Macro
More is invested if the opportunity cost of
borrowing is lower
Downward sloping investing demand
curve is derived
form horizontal sum of all industries’
downward sloping investment demand curves
See next slide
22
Nominal interest rate (percent)
Investment Demand Curve
10
8
6
D
0
0.7 0.8 0.9
Investment spending
(trillions of dollars)
23
Planned Investment and Income
Investment depends more on
interest rates
business expectations
than on
the prevailing level of income
Investment decision is said to be
“forward looking”
24
Investment Function
The simplest investment function:
planned investment is unrelated to the
current disposable income
Planned investment does not vary as real
disposable income does
Two determinants of investment that
are assumed to be constant along the
investment function curve
The market interest rate
Business expectations
See next slide
25
Real planned investment
(trillions of dollars)
Investment Function
The horizontal investment functions
imply that planned investment does
not vary with real disposable income
0.9
I"
0.8
I
0.7
I'
0
2.0
4.0
6.0
8.0
10.0
12.0
Real disposable income
(trillions of dollars)
26
Market Interest Rate
In last slide, if rate=8%, planned
investment=$0.8 trillion Î shown as I
If rate drop from 8% to 6%
Increase planned investment from $0.8 to
$0.9 trillion
Function shifts upward from I to I“
If rate increase from 8% to 10%
Increase planned investment from $0.8 to
$0.7 trillion
Function shifts downward from I to I’
27
Business Expectations
If firms become more pessimistic
Planned investment will decrease
Shift from I to I’
If profit expectations become rosier
Investment function shift upward from I to I”
Factors that Affect Business Expectations
Wars
Technological change
Changes in the tax structure
Other destabilizing (不穩定) events that make longterm planning more uncertain
28
Aggregate Expenditure
Components
Consumption
Investment
Government
Net Exports
Composition of Aggregate Expenditure
© 2003 South-Western/Thomson Learning
29
Government Purchase Function
The government purchase function
relates
government purchases
level of income in the economy
Decisions about government purchases
Almost controlled by public officials,
do not depend directly on the level of
income
we assume that government purchases,
G, are independent of the level of
income
30
Transfer Payments
Another components of government
outlays
Ex:
• Social Security
• Unemployment benefits
Transfer payments vary inversely with
income Î as income increases, transfer
payments decline
31
Net Taxes
To fund government outlays, governments
impose taxes
Taxes vary directly with income Î as income
increase, so do taxes
Net taxes= taxes - transfers
Taxes tend to increase with income
Transfers decrease with income,
Net taxes is positively related to income
real GDP-NT=DI
Net taxes affect aggregate spending indirectly by
changing disposable income, which in turn changes
consumption
32
Net Exports
Imports
If incomes rise,
• Spend more on import
Incomes decline Æspend less on
imports
Exports
Purchased by the rest of the world
Depends on the income of foreigners
Not on the U.S. level of income
33
Net Export Function
The net export function shows the
relationship between
net exports
level of income
Net exports= Exports minus imports
tend to decline as U.S. income increase
For simplicity, we will assume that net
exports are independent of the level of
income
34
Nonincome Determinants of Net Exports
Factors assumed constant along the net
export function include
The U.S. price level
Price levels in other countries
Interest rates here and abroad
Foreign income levels
Exchange rates between the dollar and
foreign currencies
Next slide illustrates the effect of a
change in one of these factors, the
exchange rate
35
Net exports (billions of dollars)
Autonomous Net Export Function
0
2.0
–80
4.0
6.0
8.0
10.0 12.0
Real disposable income
(trillions of dollars)
X"– M" 美金貶值
–100
X–M
–120
X' – M' 美金升值
36
課堂報告
請解釋何謂Consumption function
請解釋何謂Net wealth,並說明Net wealth
對於consumption function的影響
請說明在本章中,公司使用投資報酬率
(rate of return)和市場利率決定投資金額
請說明net taxes和income的關係
37
Homework
10. Consumption function
11. MPC and MPS
38