Basic
Macroeconomic
Basic
Macroeconomic
Relationships
Relationships
27-2
CHAPTER
OBJECTIVES
Effect of changes in income on
consumption (and saving)
Other factors that affect
consumption
Effect of changes in real interest
rates on investment
Other factors that affect investment
Changes in investment have a
multiplier effect on real GDP
BASIC RELATIONSHIPS
27-3
What are the two things we can do with
our income?
•Consume (spend) or Save
Disposable income (DI)
•After taxes
45°line for reference
•C = DI on the Line
•*****turn to pg. 615
S = DI - C
INCOME CONSUMPTION AND
SAVING
LO1
CONSUMPTION AND SAVING
The consumption schedule
The saving schedule
Break-even income
When households spend their entire incomes
Consumption
APC =
Income
APS =
Saving
Income
27-5
Average propensity to consume (APC)
Average propensity to save (APS)
On average, what percentage of our
incomes do we, as Americans, consume?
FALLACY OF COMPOSITION
The false assumption that what is true
for a part will also be true for the
whole.
• Your experience is YOUR experience…
• …Here, we are measuring the aggregate.
27-7
BE CAREFUL NOT TO GENERALIZE
BASED ON YOUR OWN EXPERIENCE!!
Marginal Propensity to Consume
Marginal Propensity to Consume (MPC)
•How much people consume rather than save
when there is an change in income.
•It is always expressed as a fraction (decimal).
MPC=
Change in Consumption
Change in Income
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Examples:
1. If you received $100 and spent $50.
2. If you received $100 and spent $80.
3. If you received $100 and spent $100.
Marginal Propensity to Save
Marginal Propensity to Save (MPS)
•How much people save rather than consume
when there is an change in income.
•It is also always expressed as a fraction (decimal)
MPS=
Change in Savings
Change in Income
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Examples:
1. If you received $100 and save $50.
2. If you received $100 your MPC is .7 what is
your MPS?
MPC + MPS = 1
Why is this true?
Because people can either save or consume
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ACDC Leadership 2015
CONSUMPTION AND SAVING
SCHEDULES
Consumption and Saving Schedules (in Billions) and Propensities to Consume and Save
(1)
Level of
Output and
Income
GDP=DI
(1) $370
(4)
(6)
(7)
Marginal
Propensity to
Consume
Marginal
Propensity to
Save
(MPS),
(3)/(1)*
Average
Propensity to
Consume
(APC),
Average
Propensity to
Save (APS),
(2)/(1)
(3)/(1)
(MPC),
(2)/(1)*
(5)
(2)
Consumption
(C)
(3)
Saving (S),
(1) – (2)
$375
$-5
1.01
-.01
.75
.25
(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
Consumption (billions of dollars)
CONSUMPTION AND
SAVING
500
C
475
450
425
Saving $5 Billion
Consumption
Schedule
400
375
Dissaving $5 Billion
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
27-12
Saving
(billions of dollars)
45°
NON-INCOME DETERMINANTS OF
CONSUMPTION AND SAVING
Wealth
•When wealth suddenly increases,
people consume more
Borrowing
Real interest rates
27-13
•Easy credit increases consumption,
sometimes above disposable
income…but debt needs repaid in the
future
Expectations
WHAT DO YOU NOTICE
ABOUT THE EARLY
HOW ABOUT
2000’S?
‘09 ONWARD?
LO1
INTEREST RATE AND INVESTMENT
Expected rate of return on capital (r)
The real interest rate (i)
•Nominal rate less rate of inflation
Meaning of r = i
•Firms will invest as long as r ≥ i
27-15
Investment demand curve
(r)
and
(i)
16%
$0
14
5
12
10
10
15
8
20
6
25
4
30
2
35
0
LO3
Investment
(billions
of dollars)
40
Expected rate of return, r
and real interest rate, i (percents)
INVESTMENT DEMAND CURVE
16
14
Investment
demand
curve
12
10
8
6
4
2
ID
0
5
10
15
20
25
30
35
Investment (billions of dollars)
40
INVESTMENT DEMAND CURVE
•Acquisition, maintenance, and
operating costs
•Business taxes
•Technological change
•Stock of capital goods on hand
•Planned inventory changes
•Expectations
27-17
Shifts of the curve
SHIFTS OF INVESTMENT DEMAND
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)
INVESTMENT DEMAND
Instability of investment
•Durability
•Irregularity of innovation
•Variability of profits
•Variability of expectations
27-19
Consumption and Saving tend
to be more stable than
investment
INSTABILITY OF INVESTMENT
LO4
27-21
REVIEW
PG. 633 #1, 2
THE MULTIPLIER
EFFECT
Why do cities want the Super Bowl in their
stadium?
An initial change in spending will set off a spending chain
that is magnified in the economy.
Example:
•
•
•
•
Bobby spends $100 on Jason’s product
Jason now has more income so he buys $100 of Nancy’s product
Nancy now has more income so she buys $100 of Tiffany’s
product.
The result is an $300 increase in consumer spending
The Multiplier Effect shows how spending is
magnified in the economy.
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THE MULTIPLIER
EFFECT
• More spending results in higher
GDP
• Initial change in spending changes
GDP by a multiple amount
Multiplier =
Change in Real GDP
Initial Change in Spending
27-24
Change in GDP = Multiplier x Initial Change in Spending
Causes of the initial change in spending
• Most prevalent - Changes in investment
• Become increases in wage, rent,
interest, profit
• Other changes:
• C (confidence?)
• G (stimulus?)
• X (exchange rates?)
Rationale
• Dollars spent are received as income
• Income received is spent (MPC)
• Initial changes in spending cause a
spending chain
27-25
THE MULTIPLIER EFFECT
How is Spending “Multiplied”?
Assume the MPC is .5 for everyone
•Assume the Super Bowl comes to town and there is an
increase of $100 in Ashley’s restaurant.
•Ashley now has $100 more income.
•She saves $50 and spends $50 at Karl’s Salon
•Karl now has $50 more income
•He saves $25 and spends $25 at Dan’s fruit stand
•Dan now has $25 more income.
This continues until every penny is spent or saved
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ACDC Leadership 2015
= Multiplier
x
Initial Change
in Spending
26
Total change
in GDP
Calculating the Spending Multiplier
If the MPC is .75 how much is the multiplier?
Spending
Multiplier
OR
•If the multiplier is 4, how much will an initial
increase of $5 in Government spending increase
the GDP?
•How much will a decrease of $3 in spending
decrease GDP?
Total change = Multiplier
Initial Change
in GDP
in Spending
x
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The Multiplier Effect
Let’s practice calculating the spending multiplier
OR
1. If MPC is .9, what is multiplier?
2. If MPC is .8, what is multiplier?
3. If MPC is .5, and consumption increased
$2M. How much will GDP increase?
4. If MPC is 0 and investment increases $2M.
How much will GDP increase?
Conclusion: As the Marginal Propensity to
Consume falls, the Multiplier Effect is less
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Spending
Multiplier
THE MULTIPLIER AND
THE MPC
MPC
Multiplier
.9
10
.8
5
.75
4
.67
2
27-29
.5
3
HOMEWORK
27-30
Read pgs. 659-670
and complete
AD/AS packet