Income, Consumption, and Saving
• Consumption and saving
• Primarily determined by Disposable Income
• Direct relationship – as DI increases, so does
consumption.
• Saving is what’s left over, what’s not spent.
• Households spend a higher percentage of a
small disposable income than of a large
disposable income.
Important – This is all IN THE AGGREGATE. It does not represent each
individual household, or even any individual household. It is all
households combined, according to studies done by economists
LO1
27-1
Income, Consumption, and Saving
LO1
27-2
Consumption and Saving Schedules
Consumption and Saving Schedules (in Billions) and Propensities to Consume and Save
(4)
(1)
Level of
Output
and
Income
GDP=DI
(2)
Consumption
(C)
(3)
Saving
(S),
(1) – (2)
(1) $370
$375
(6)
Average
Propensity
to
Consume
(APC),
Average
Propensity
to Save
(APS),
(2)/(1)
$-5
(7)
Marginal
Propensity
to
Consume
Marginal
Propensity
to Save
(3)/(1)
(MPC),
(2)/(1)*
(MPS),
(3)/(1)*
1.01
-.01
.75
.25
(5)
(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
LO1
27-3
Consumption (billions of dollars)
Consumption and Saving Schedules
500
C
475
450
425
Saving $5 billion
Consumption
schedule
400
375
Dissaving $5 billion
Saving
(billions of dollars)
45°
370 390 410 430 450 470 490 510 530 550
50
25
0
Dissaving Saving schedule
S
$5 billion
Saving $5 billion
370 390 410 430 450 470 490 510 530 550
Disposable income (billions of dollars)
LO1
27-4
Average Propensities
• Average propensity to consume (APC)
• Fraction of total income consumed
• Average propensity to save (APS)
• Fraction of total income saved
consumption
APC =
income
APS =
saving
income
APC + APS = 1
LO1
27-5
Global Perspective
LO1
27-6
Marginal Propensities
• Marginal propensity to consume (MPC)
• Proportion of a change in income
•
consumed
Marginal propensity to save (MPS)
• Proportion of a change in income saved
MPC =
change in consumption
change in income
MPS =
change in saving
change in income
MPC + MPS = 1
LO1
27-7
Marginal Propensities
C
Consumption
15
MPC = 20 = .75
C ($15)
Saving
DI ($20)
MPS =
5
= .25
20
S
S ($5)
DI ($20)
Disposable income
LO1
27-8
Nonincome Determinants
•
•
LO2
Amount of disposable income is the main
determinant
Other determinants
• Wealth
• Expectations
• Real interest rates
• Household Debt
• Taxation – the only one that shifts both
consumption and saving in the same direction.
27-9
The Multiplier Effect
• A change in spending changes real GDP more
than just the initial change in spending
Multiplier =
change in real GDP
initial change in spending
Change in GDP = multiplier x initial change in spending
LO5
The Multiplier Effect
(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
LO5
$4.75
$1.58
15.25
13.67
$2.11
$2.81
11.56
8.75
5.00
$3.75
$5.00
1
2
3
4
5
All others
Multiplier and 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 =
1
MPS
Multiplier and Marginal Propensities
MPC
Multiplier
.9
10
.8
5
.75
4
.67
.5
LO5
3
2
The Actual Multiplier Effect?
• Actual multiplier is lower than the model
assumes
• Consumers buy imported products
• Households pay income taxes
• Inflation
• Multiplier may be 0
LO5
Interest Rate and Investment
• Expected rate of return and the real
interest rate.
– If the expected rate of return is greater than the
real interest rate, then the firm should undertake
the investment.
– Applies to borrowing or to cash on hand.
LO3
27-16
Investment Demand Curve
16%
$0
14
5
12
10
10
15
8
20
6
25
4
30
2
35
0
LO3
Investment
(billions
of dollars)
40
16
Expected rate of return, r
and real interest rate, i (percents)
(r)
and
(i)
14
Investment
demand
curve
12
10
8
6
4
2
ID
0
5
10
15
20
25
30
35
40
Investment (billions of dollars)
27-17
Shifts of Investment Demand
• Acquisition, maintenance, and operating
•
•
•
•
•
LO4
costs
Business taxes
Technological change
Stock of capital goods on hand
Planned inventory changes
Expectations
27-18
Expected rate of return, r, and
real interest rate, i (percents)
Shifts of Investment Demand
Increase
in investment
demand
Decrease in
investment
demand
0
LO4
ID2 ID0 ID1
Investment (billions of dollars)
27-19
Global Perspective
LO4
27-20