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1 Chapter 21 Consumption & Investment 4/13/2015 © ©1999 South-Western College Publishing.

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Presentation on theme: "1 Chapter 21 Consumption & Investment 4/13/2015 © ©1999 South-Western College Publishing."— Presentation transcript:

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2 1 Chapter 21 Consumption & Investment 4/13/2015 © ©1999 South-Western College Publishing

3 2 What is the Consumption Function? The relationship between consumption and income C = F(Y) © ©1999 South-Western College Publishing

4 3 The Consumption Function Real Disposable Income Real Consumption C CC YY © ©1999 South-Western College Publishing

5 4 What is Saving? That part of national income not spent on consumption © ©1999 South-Western College Publishing

6 5 Income C 45 o Saving Consumption Function Consumption, Saving 5 © ©1999 South-Western College Publishing

7 6 Y C 45 o 6 C, S Y1 Y2 Y3

8 7 On the previous graph, At Y1, C=Y, so S=0 At Y2, CY, negative savings (dissaving

9 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)

10 9 What is the Marginal Propensity to Save(MPS)? The change in saving induced by a change in income © ©1999 South-Western College Publishing

11 10 MPC = ΔC/ ΔY MPS = ΔS/ ΔY Example: Y = 500, C = 400, S = 100 Y 1 = 600, C 1 = 480, S 1 = 120 ΔY= 100, ΔC = 80, ΔS=20 so MPC = 80/100 =.8 MPS = 20/100 =.2 

12 11 Note that MPC + MPS must equal 1

13 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 © ©1999 South-Western College Publishing

14 13 What is Autonomous Consumption? Consumption spending that is independent of the level of income © ©1999 South-Western College Publishing

15 14 What is significant about Autonomous Consumption? Even when income is zero, autonomous spending is positive © ©1999 South-Western College Publishing

16 15 The Consumption Function Real Disposable Income Real Consumption C CC YY a

17 16 What is the Consumption Equation? C = a + bY © ©1999 South-Western College Publishing Autonomous Consumption MPC Income

18 17 Many theories of the consumption function Note that a straight line C function assumes a constant MPC

19 18 Who was John Maynard Keynes? Economist who had a book published in 1936 named “The General Theory of Employment, Interest and Money” © ©1999 South-Western College Publishing

20 19 What is Keynes’ Absolute Income Hypothesis? As income increases, consumption spending increases, but by diminishing amounts © ©1999 South-Western College Publishing

21 20 According to the absolute income hypothesis, What happens to the MPC as income increases? MPC decreases as income increases and increases as income decreases © ©1999 South-Western College Publishing

22 21 Who was Simon Kuznets? An economists who published a book in 1941 named “National Income and Its Composition” © ©1999 South-Western College Publishing

23 22 What did Kuznets say in his book? MPC tends to remain fairly constant regardless of the absolute level of national income © ©1999 South-Western College Publishing

24 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 © ©1999 South-Western College Publishing

25 24 What is the Permanent Income Hypothesis? A person’s consumption spending is related to his or her permanent income © ©1999 South-Western College Publishing

26 25 What is Permanent Income? The regular income a person expects to earn annually © ©1999 South-Western College Publishing

27 26 Who is Milton Friedman? An economists who won the Nobel Prize in Economics in 1976 © ©1999 South-Western College Publishing

28 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 © ©1999 South-Western College Publishing

29 28 Who is Franco Modigliani? An economists who won the Nobel Prize in Economics in 1985 © ©1999 South-Western College Publishing

30 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 © ©1999 South-Western College Publishing

31 30 What can cause a shift in the Consumption Function? Real assets & money holdings Expectations of price changes Credit & interest rates Taxation © ©1999 South-Western College Publishing

32 31 Real Disposable Income Real Consumption C1C1 C2C2 © ©1999 South-Western College Publishing

33 32 For more information on income data: income.html bl.htm © ©1999 South-Western College Publishing

34 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 © ©1999 South-Western College Publishing

35 34 Real Disposable Income Real Consumption Consumption Income Line A B © ©1999 South-Western College Publishing

36 35 What is Intended Investment? Investment spending that producers intend to undertake, on plant, tools, construction, and inventory © ©1999 South-Western College Publishing

37 36 What is Autonomous Investment? Investment that is independent of the level of income © ©1999 South-Western College Publishing

38 37 National Income 45 o Investment 37 I

39 38 What determines Autonomous Investment? Level of technology Interest rate Expectations of growth Rate of capacity utilization © ©1999 South-Western College Publishing

40 39 National Income C 45 o Consumption, Saving 39 (C+I)

41 40 Why is Investment Volatile? Because what can change investors expectations is unpredictable sometime © ©1999 South-Western College Publishing

42 41 What determines Consumption? What is Keynes’ Absolute Income Hypothesis?What is Keynes’ Absolute Income Hypothesis? What is MPC? What happens to MPC as income increases?What happens to MPC as income increases? What did Kuznets say in his book? What is Duesenberry’s Relative Income Hypothesis?What is Duesenberry’s Relative Income Hypothesis?

43 42 What is the Permanent Income Hypothesis?What is the Permanent Income Hypothesis? What is Friedman’s contribution to Income Hypothesis?What is Friedman’s contribution to Income Hypothesis? What is Modigliani’s Life Cycle Hypothesis?What is Modigliani’s Life Cycle Hypothesis? What is Autonomous Consumption? What is Saving? What is the MPS? What is Autonomous Investment?

44 43 ENDEND © ©1999 South-Western College Publishing


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