1. Consumption & Investment
Chapter 21
Consumption & Investment
4/10/2017
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2. What is the Consumption Function?
The relationship between consumption and income
C = F(Y)
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3. The Consumption Function
D C
Real Consumption
D Y
Real Disposable Income
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4. What is Saving? That part of national income not spent on consumption
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5. C Income Consumption Function Consumption, Saving Saving 45o 5
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6. C, S C
45o Y Y3 Y1 Y2 6

7. On the previous graph,
At Y1, C=Y, so S=0
At Y2, C<Y, positive savings
At Y3, C>Y, negative savings (dissaving

8. What is the Marginal Propensity to consume (MPC)?
Change in consumption brought about by a change in income (the slope of the consumption function)

9. What is the Marginal Propensity to Save(MPS)?
The change in saving induced by a change in income
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10. MPC = ΔC/ ΔY MPS = ΔS/ ΔY Example: Y = 500, C = 400, S = 100 Y1 = 600, C1 = 480, S1 = 120 ΔY= 100, ΔC = 80, ΔS=20 so MPC = 80/100 = .8 MPS = 20/100 = .2

11. Note that MPC + MPS must equal 1

12. If household's income rises from $30,000 to $33,000 and consumption rises from $28,000 to $30,000, then
MPC = $2000 / $3,000 = .67
MPS = $1000 / $3,000 = .33
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13. What is Autonomous Consumption?
Consumption spending that is independent of the level of income
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14. What is significant about Autonomous Consumption?
Even when income is zero, autonomous spending is positive
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15. The Consumption Function
Real Consumption
D C a
D Y
Real Disposable Income

16. What is the Consumption Equation?
C = a + bY
Income
Autonomous Consumption
MPC
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17. Many theories of the consumption function
Note that a straight line C function assumes a constant MPC

18. Who was John Maynard Keynes?
Economist who had a book published in 1936 named “The General Theory of Employment, Interest and Money”
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19. What is Keynes’ Absolute Income Hypothesis?
As income increases, consumption spending increases, but by diminishing amounts
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20. MPC decreases as income increases and increases as income decreases
According to the absolute income hypothesis, What happens to the MPC as income increases?
MPC decreases as income increases and increases as income decreases
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21. Who was Simon Kuznets?
An economists who published a book in 1941 named “National Income and Its Composition”
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22. What did Kuznets say in his book?
MPC tends to remain fairly constant regardless of the absolute level of national income
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23. What is Duesenberry’s Relative Income Hypothesis?
People consume according to their relative position in society, consistent with the idea that the MPC remains fairly constant as national income increases
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24. What is the Permanent Income Hypothesis?
A person’s consumption spending is related to his or her permanent income
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25. What is Permanent Income?
The regular income a person expects to earn annually
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26. Who is Milton Friedman?
An economists who won the Nobel Prize in Economics in 1976
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27. What is Friedman’s contribution to Income Hypothesis?
People distinguish between their regular income and income they expect to make or lose in any one year
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28. Who is Franco Modigliani?
An economists who won the Nobel Prize in Economics in 1985
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29. What is Modigliani’s Life Cycle Hypothesis?
Typically, a person’s MPC is relatively high during young adulthood, decreases during middle age, and then increases
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30. What can cause a shift in the Consumption Function?
Real assets & money holdings
Expectations of price changes
Credit & interest rates
Taxation
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31. C1 C2 Real Consumption Real Disposable Income
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32. For more information on income data:
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33. Will a change in Income cause a shift in C?
No!
When income changes there is a movement along a stationary Consumption Function Curve
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34. B A Real Consumption Real Disposable Income Consumption Income Line
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35. What is Intended Investment?
Investment spending that producers intend to undertake, on plant, tools, construction, and inventory
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36. What is Autonomous Investment?
Investment that is independent of the level of income
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37. Investment I
45o
National Income
3737

38. What determines Autonomous Investment?
Level of technology
Interest rate
Expectations of growth
Rate of capacity utilization
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39. (C+I)
Consumption, Saving C
45o
National Income
3939

40. Why is Investment Volatile?
Because what can change investors expectations is unpredictable sometime
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41. What determines Consumption?
What is Keynes’ Absolute Income Hypothesis?
What is MPC?
What happens to MPC as income increases?
What did Kuznets say in his book?
What is Duesenberry’s Relative Income Hypothesis?

42. What is the Permanent Income Hypothesis?
What is Friedman’s contribution to Income Hypothesis?
What is Modigliani’s Life Cycle Hypothesis?
What is Autonomous Consumption?
What is Saving?
What is the MPS?
What is Autonomous Investment?

43. END
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