Ch 8. Basic Macroeconomic
Relationships
A.
Income & consumption schedules.
Consumption and
disposable income,
1980 – 2002.
Each dot shows
consumption and
DI in a given year.
Line C generalizes
the relationship
between consumption
& DI, indicates a
direct relationship
and shows that
households consume
most of their incomes.
-- Savings (S) equals disposable income (DI) minus consumption (C).
-- 45 degree line shows all points where DI and C are equal.
-- The Consumption Schedule and the Savings Schedule.
Basic Relationships
• Income-Consumption
• Income-Saving
• 45° Line
• C = DI on the Line
• S = DI - C
B.
APC (average propensity to consume)
APC = consumption
income
C.
If a family’s C > DI,
The APC is > 1.
APS (average propensity to save)
APS = saving
income
-- From the schedule before, the APC is 450 = 45 or about 96%.
470 47
-- The APS is 20 = 2 or about 4%.
470 47
-- ‘Average’ is for one year.
APC + APS = 1
Consumption and Saving
GLOBAL PERSPECTIVE
Average Propensities to Consume
Select Nations GDPs
Average Propensities to Consume
.80
.85
.90
.95
1.00
United States
.963
Canada
.958
United Kingdom
.953
Japan
.942
Germany
.896
Netherlands
.893
Italy
France
.840
.833
Source: Statistical Abstract of the United States, 2006
D.
MPC (marginal propensity to consume)
MPC = change in consumption
change in income
E.
MPS (marginal propensity to save)
MPS = change in saving
change in income
MPC + MPS = 1
-- ‘Marginal’ is over time
MPC + MPS = APC + APS
-- The graph is on the next slide.
•
(a) consumption
and (b) saving
schedule.
•
The saving
schedule in (b) is
found by
subtracting the
consumption
schedule in (a)
vertically from the
45 degree line.
•
Consumption
equals disposable
income (and
savings equals
zero) at $390 billion
in this example.
Consumption and Saving
(1)
Level of
(2)
Output
ConsumpAnd
tion
Income
(C)
(GDP=DI)
(1) $370
(4)
(5)
(6)
(7)
Average
Average
Marginal
Marginal
Propensity Propensity Propensity Propensity
(3)
to Consume to Save
to Consume to Save
Saving (S)
(APC)
(APS)
(MPC)
(MPS)
(1-2)
(2)/(1)
(3)/(1)
Δ(2)/Δ(1)
Δ(3)/Δ(1)
$375
$-5
1.01
-.01
(2)
390
390
0
1.00
.00
(3)
410
405
5
.99
.01
(4)
430
420
10
.98
.02
(5)
450
435
15
.97
.03
(6)
470
450
20
.96
.04
(7)
490
465
25
.95
.05
(8)
510
480
30
.94
.06
(9)
530
495
35
.93
.07
(10) 550
510
40
.93
.07
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
Consumption and Saving
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
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
Consumption and Saving
Consumption and Saving Schedules
Consumption (billions of dollars)
C1
C0
C2
Saving
(billions of dollars)
45°
Disposable Income (billions of dollars)
S2
S0
S1
F.Expected Rate of Return – anticipated profit
from investment.
r = is expected to be 10%
(on a $1,000 investment = $100/$1,000)
G.
Real Interest Rate – expressed in
dollars (adjusted for inflation) & = to
nominal interest rate less the rate of
inflation.
i = $1,000 times 7% = $70 ($30 profit)
-- The interest-Rate-Investment Relationship.
-- Investment is expenditures on new plants, equipment, machinery, etc.
-- Nominal interest rate is not adjusted for inflation.
H.
Investment Demand Curve
Rates of Expected Return and
Investment
Expected
Rate of
Return (r)
25%
20
15
10
5
0
Cumulative amount
of investment having
this rate of return
or higher (in billions)
$0
$10
20
30
40
50
Investment Demand Curve
Inverse
Relationship
(sloping down)
-- We move from a single firm’s investment to total demand by entire business sector.
-- This shows the amount of investment forthcoming at each real interest rate.
-- The level of investment depends on the expected rate of return & real interest rate.
I.
Shifts
1. Operating
costs.
2. Business
taxes.
3. Tech
changes.
4. Stock of
goods.
5. Expectations.
Shifts of the Investment Demand Curve
-- When these things change, the Demand Curve shifts.
-- If businesses expect greater returns on their investments it increases investment
demand and shifts the demand curve to the right (from ID₀ to ID₁).
-- Expected lower rates of return moves the shift to the left (from ID₀ to ID₂).
Interest Rate and Investment
Shifts in the Investment
Demand Curve
r and i (percent)
Increase in
Investment Demand
Decrease in
Investment Demand
0
Investment (billions of dollars)
ID2 ID0
ID1
6. Instability of investment.
7. Durability.
8. Irregularity of innovation.
9. Variability of profits.
10.
“
of expectations.
Interest Rate and Investment
Percentage Change
The Volatility of Investment
Gross Investment
GDP
1971 1975
1979
1983
1987 1991
Year
1995
1999
2003
J.
Multiplier Effect:  spending =  GDP.
Multiplier = Δ in real GDP
initial Δ in spending
If investment rises by $30 billion and the GDP rises by $90 billion,
we then know that the multiplier is 3 (= $90/30).
-- Other things equal, there is a direct relationship between changes in spending and
changes in real GDP.
-- The multiplier determines how much larger that change will be.
-- Or, Change in GDP = multiplier x initial change in spending.
MPC &
MPS are
#D & E
•
•
•
•
•
•
$5 bill increase in the incomes
of households
MPC in .75
Raises consumption by $3.75
(.75 x $5)
Savings by $1.25 (= .25 x $5
bill) column 2&3.
2nd round has $3.75 in
consumption.
Consume .75 of $3.75 ($2.81
bill), and save .25 ($.94 bill)
-- Initial change of investment spending of
$5 bill creates and equal $5 bill of new income.
-- The multiplier is 4 (= $20 bill/$5 bill).
The MPC and the multiplier are directly
related and the MPS and the multiplier are
inversely related.
Multiplier =
1
1 – MPC
Multiplier =
1
MPS
-- Remember that MPC + MPS = 1.
-- Therefore, MPS = 1 – MPC.