macroeconomic mcgrowhill macro ch 10 19e use this one

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 factor

Basic Macroeconomic

Relationships10

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc All rights reserved.

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

Income Consumption and Saving

Income, Consumption, and Saving

Average Propensities

saving

APC + APS = 1

Consumption and Saving

Global Perspective

Marginal Propensities

• Marginal propensity to consume (MPC)

• Marginal propensity to save (MPS)

Consumption and Saving

(C)

(3) Saving (S), (1) – (2)

(4)

Average Propensity

to Consume (APC ), (2)/(1)

(5)

Average Propensity

to Save (APS),

(3)/(1)

(6)

Marginal Propensity

to Consume

(MPC),

∆(2)/∆(1)*

(7)

Marginal Propensity

PRACTICE QUIZ 1

A nation has a disposable income in 2010 of $620

Billion dollars In this year the nation spends $545.6 Billion in consuming goods and services In 2011, disposable income increases to $629 Billion and the nation saves $1.8 Billion of the additional income

•What is the APC in 2010?

•What is the APS in 2010?

•What is the MPC of this nation?

•What is the MPS of this nation?

•What is the APC in 2011?

•What is the APS in 2011?

PRACTICE QUIZ 2 ($ Dollars in Billions)

•Year 1: Income = 150, Consumption = 155, Savings = ?, APC = ?, APS = ?

•Year 2: I = 180, S = 3, C = ?, APC = ?, APS = ?

•Year 3: I = 240, C = 221, S = ?, APC = ?, APS

Nonincome Determinants

• Amount of disposable income is

the main determinant

Other Important Considerations

Shifts of C & S Schedules

+

• Expected rate of return

• The real interest rate

• Investment demand curve

Investment Demand Curve

Shifts of Investment Demand

• Acquisition, maintenance, and

operating costs

• Business taxes

• Technological change

• Stock of capital goods on hand

• Planned inventory changes

• Expectations

Shifts of Investment Demand

Decrease in investment demand

Global Perspective

Instability of Investment

Source: Bureau of Economic Analysis, http://www.bea.gov.

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

The Multiplier Effect

(1) Change in Income

(2) Change in Consumption (MPC = 75)

(3) Change in Saving (MPS = 25)

1

Multiplier and Marginal

Propensities

• Multiplier and MPC directly related

• Multiplier and MPS inversely related

Multiplier = 1

1- MPC Multiplier =

1 MPS

Multiplier and Marginal

.67 75 8

.9

The Actual Multiplier Effect?

• Actual multiplier is lower than the

model assumes

• Consumers buy imported products

• Households pay income taxes

• Inflation

• Actual Multiplier is estimated at 2.5

or less

Squaring the Economic Circle

multiplier

buy a product

spending, following the first decision

experiences an economic downturn

10-28

• marginal propensity to save (MPS)

• wealth effect

• expected rate of return

• investment demand curve

• multiplier