PowerPoint Presentation by
Mehdi Arzandeh, University of Manitoba
Basic
Macroeconomic
Relationships
10
LEARNING OBJECTIVES
LO10.1
LO10.2
LO10.3
LO10.4
LO10.5
Describe how changes in income affect consumption (and saving).
List and explain factors other than income that can affect consumption.
Explain how changes in real interest rates affect investment.
Identify and explain factors other than the real interest rate that can affect
investment.
Illustrate how changes in investment (or one of the components of total spending)
increase or decrease real GDP by a multiple amount.
© 2016 McGraw‐Hill Education Limited
10-2
10.1
The Income-Consumption and
Income-Saving Relationship
• Consumption and saving
• Primarily determined by Disposable Income (DI)
• Direct relationship
• Consumption schedule (C)
• Planned household spending (in our model)
• Saving schedule (S)
• DI minus C
• Dissaving can occur
LO1
© 2016 McGraw‐Hill Education Limited
10-3
FIGURE 10-1
Consumption and Disposable Income, 1992-2014
The line C, which generalizes the relationship
between consumption and disposable income,
indicates a direct relationship and shows that
households consume most of their income.
LO1
© 2016 McGraw‐Hill Education Limited
10-4
TABLE 10-1
(1)
Level of
Output and
Income
GDP=DI
(1) $370
Consumption and Saving Schedules and Propensities
to Consume and Save (billions of dollars)
(4)
Average
Propensity to
Consume
(APC),
Average
Propensity to
Save (APS),
(2)/(1)
(3)/(1)
(5)
(2)
Consumption
(C)
(3)
Saving (S),
(1) – (2)
$375
$-5
1.01
-.01
(6)
(7)
Marginal
Propensity to
Consume
Marginal
Propensity to
Save
(MPC),
(2)/(1)*
(MPS),
(3)/(1)*
(2)
390
390
0
1.00
.00
.75
.25
(3)
410
405
5
.99
.01
.75
.25
(4)
430
420
10
.98
.02
.75
.25
(5)
450
435
15
.97
.03
.75
.25
(6)
470
450
20
.96
.04
.75
.25
(7)
490
465
25
.95
.05
.75
.25
(8)
510
480
30
.94
.06
.75
.25
(9)
530
495
35
.93
.07
.75
.25
(10) 550
510
40
.93
.07
.75
.25
*The Greek letter , delta, means “the change in”.
LO1
© 2016 McGraw‐Hill Education Limited
10-5
FIGURE 10-2
KEY GRAPH - Consumption and Saving Schedule
Saving
(billions of dollars)
Consumption (billions of dollars)
C
Saving $5 billion
Consumption
schedule
Dissaving $5 billion
370 390 410 430 450 470 490 510 530 550
50
25
0
Dissaving
$5 billion
Saving schedule
S
Saving $5 billion
370 390 410 430 450 470 490 510 530 550
Disposable income (billions of dollars)
LO1
© 2016 McGraw‐Hill Education Limited
10-6
10.1
The Income-Consumption and
Income-Saving Relationship
Average and Marginal Propensities
APC =
APS =
MPC =
MPS =
LO1
Table 10.1
consumption
income
APC + APS = 1
saving
income
change in consumption
change in income
MPC + MPS = 1
change in saving
change in income
© 2016 McGraw‐Hill Education Limited
10-7
10.1 GLOBAL PERSPECTIVE
Average Propensities to Consume, Selected Nations
LO1
© 2016 McGraw‐Hill Education Limited
10-8
FIGURE 10-3
The Marginal Propensity to Consume and the
Marginal Propensity to Save
C
Consumption
15
MPC = 20 = .75
C ($15)
Saving
DI ($20)
MPS =
5
= .25
20
S
S ($5)
DI ($20)
Disposable income
LO1
© 2016 McGraw‐Hill Education Limited
10-9
10.2
Non-Income Determinants of
Consumption and Saving
•WEALTH
•BORROWING
•EXPECTATIONS
•REAL INTEREST RATES
LO2
© 2016 McGraw‐Hill Education Limited
10-10
10.2
Non-Income Determinants of
Consumption and Saving
Other Important Considerations
• Switching to Real GDP
• Changes Along Schedules
• Simultaneous Shifts
• Taxation
• Stability
LO2
© 2016 McGraw‐Hill Education Limited
10-11
KEY GRAPH – Shifts in the Consumption and
Saving Schedules
FIGURE 10-4
C1
C0
Saving
(billions of dollars)
Consumption
(billions of dollars)
C2
LO2
0
S2
S0
S1
+
0
Real GDP (billions of dollars)
© 2016 McGraw‐Hill Education Limited
10-12
10.3
The Interest Rate-Investment
Relationship
•Expected Rate of Return, r
•The Real Interest Rate
• i = nominal rate - rate of inflation
• crucial in making investment decisions
•Investment Demand Curve
LO3
© 2016 McGraw‐Hill Education Limited
10-13
FIGURE 10-5
(r)
and
(i)
16%
LO3
KEY GRAPH – The Investment Demand Curve
Investment
(billions
per year)
$0
14
5
12
10
10
15
8
20
6
25
4
30
2
35
0
40
Investment
demand
curve
ID
© 2016 McGraw‐Hill Education Limited
10-14
10.4
Shifts in the Investment Demand
Curve
• Acquisition, Maintenance & Operating Costs
• Business Taxes
• Technological Change
• Stock of Capital Goods on Hand
• Planned Inventory
• Expectations
LO4
© 2016 McGraw‐Hill Education Limited
10-15
10.4
Shifts in the Investment Demand
Curve
Fluctuations of Investment
• Variability of Expectations
• Durability
• Irregularity of Innovation
• Variability of Profits
LO4
© 2016 McGraw‐Hill Education Limited
10-16
FIGURE 10-6
Shifts in the Investment Demand Curve
Expected rate of return, r, and
real interest rate, i (percents)
Increase
in investment
demand
Decrease in
investment
demand
0
LO4
ID2 ID0
ID1
Investment (billions of dollars)
© 2016 McGraw‐Hill Education Limited
10-17
10.2 GLOBAL PERSPECTIVE
Gross Investment Expenditures as a Percentage of GDP,
Selected Nations
LO4
© 2016 McGraw‐Hill Education Limited
10-18
FIGURE 10-7
LO4
The Volatility of Investment, 1973-2014
© 2016 McGraw‐Hill Education Limited
10-19
10.5 The Multiplier Effect
•A change in spending changes real GDP more
than the initial change in spending
Multiplier =
change in real GDP
initial change in spending
Change in GDP = multiplier x initial change in spending
LO5
© 2016 McGraw‐Hill Education Limited
10-20
10.5 The Multiplier Effect
The “Initial Change in Spending”
• Associated with investment spending because of
investment’s volatility
• Associated with investment spending results from either a
change in the real interest rate or a shift of the ID curve
• May create a multiple increase in GDP and a decrease in
spending may be multiplied into a large decrease in GDP
• Simple multiplier, closed economy multiplier
LO5
© 2016 McGraw‐Hill Education Limited
10-21
FIGURE 10-8
The Multiplier Process (MPC = 0.75)
(1)
Change in Income
(2)
Change in
Consumption
(MPC = .75)
(3)
Change in Saving
(MPS = .25)
$5.00
$3.75
$1.25
Second round
3.75
2.81
.94
Third round
2.81
2.11
.70
Fourth round
2.11
1.58
.53
Fifth round
1.58
1.19
.39
All other rounds
4.75
3.56
1.19
$20.00
$15.00
$5.00
Increase in investment of $5.00
Total
Cumulative income,
GDP (billions of dollars)
20.00
$4.75
15.25
13.67
$1.58
$2.11
11.56
$2.81
8.75
$3.75
5.00
$5.00
1
LO5
2
3
4
© 2016 McGraw‐Hill Education Limited
5
All others
10-22
10.5 The Multiplier Effect
The Multiplier and the Marginal Propensities
• Multiplier and MPC directly related
• Large MPC results in larger increases in spending
• Multiplier and MPS inversely related
• Large MPS results in smaller increases in spending
Multiplier =
LO5
1
1- MPC
Multiplier =
© 2016 McGraw‐Hill Education Limited
1
MPS
10-23
FIGURE 10-9
The MPC and the Multiplier
MPC
Multiplier
.9
10
.8
5
.75
4
.67
.5
LO5
3
2
© 2016 McGraw‐Hill Education Limited
10-24
10.5 The Multiplier Effect
How Large is the Actual Multiplier Effect?
• Actual multiplier is lower than the model assumes
• Consumers buy imported products
• Households pay income taxes
• Inflation
• Multiplier may be close to zero
LO5
© 2016 McGraw‐Hill Education Limited
10-25
The LAST
WORD
Squaring the Economic Circle
• Humorous small town example of the multiplier
• One person in town decides not to buy a product
• Creates a ripple effect of people not spending,
following the first decision
• Ultimately the entire town experiences an economic
downturn
© 2016 McGraw‐Hill Education Limited
10-26
Chapter Summary
LO10.1 Describe how changes in income affect consumption (and
saving).
LO10.2 List and explain factors other than income that can affect
consumption.
LO10.3 Explain how changes in real interest rates affect investment.
LO10.4 Identify and explain factors other than the real interest rate
that can affect investment.
LO10.5 Illustrate how changes in investment (or one of the
components of total spending) increase or decrease real GDP
by a multiple amount.
© 2016 McGraw‐Hill Education Limited
10-27