Presentation on theme: "and the Powerful Consumer"— Presentation transcript:
1 and the Powerful Consumer 24Aggregate Demandand the Powerful ConsumerMen are disposed, as a rule and on the average, to increase their consumption as their income increases, but not by as much as the increase in their income.JOHN MAYNARD KEYNES
4 AD, Domestic Product, and National Income Aggregate Demandthe total amount that all consumers, business firms, and government agencies are willing to spend on final goods and servicesConsumer Expenditurethe total amount spent by consumers on newly produced goods and services (excluding purchases of new homes, which are considered investment goods)
5 AD, Domestic Product, and National Income Investment Spendingthe sum of the expenditures of business firms on new plant and equipment and households on new homes. Financial “investments” are not included, nor are resales of existing physical assets.Government Purchasesthe goods and services purchased by all levels of government.
6 AD, Domestic Product, and National Income Net Exportsthe difference between U.S. exports and U.S. imports.Indicates the difference between what we sell to foreigners and what we buy from themAD = C + I + G + (X - IM)
7 AD, Domestic Product, and National Income the sum of the incomes that all individuals in the economy earned in the forms of wages, interest, rents, and profits.Excludes government transfer paymentsPre-tax
8 AD, Domestic Product, and National Income Disposable Incomethe sum of the incomes of all the individuals in the economy after all taxes have been deducted and all transfer payments have been addedDI = GDP - Taxes + Transfers = Y - T
9 Circular Flow of Spending, Production, and Income Circular flow diagram: shows the relationship of the different components of expenditure and incomeNational income = domestic product
10 FIGURE 24-1 The Circular Flow of Expenditures and Income Rest of theWorldFinancial SystemC + IConsumption (C)Investment (I)23C + I + GPurchases (G)Imports (IM)Saving (S)Exports (X)Investors4GovernmentC + I + G +Consumers1Government(X – IM)DisposableFirms(produce thedomestic product)TransfersTaxes56Income (DI)GrossNationalIncome (Y)
11 Consumer Spending and Income A scatter diagram with U.S. data shows the close relationship between real disposable income and real consumer spending.
15 Consumer Spending and Income When the data are converted into a consumption function diagram--with income on one axis and consumption on the other--the relationship between real consumer spending and real disposable income is almost linear, with a slope of about 0.9.
16 The Consumption Function and the MPC illustrates the relationship between total consumer expenditures and total disposable income in the economy, holding constant all other determinants of consumer spending.MPC = consumption disposable incomeCan be used to estimate the initial effect on consumer spending of a tax cut
21 Factors That Shift the Consumption Function Consumption function shifted by changes in:WealthPrice levelReal interest rateExpectations of future income
22 Why The Tax Rebate Failed in 1975 and 2001 ?Why The Tax Rebate Failed in 1975 and 2001The tax cuts failed to stimulate consumption very much because they were perceived as only temporary.People probably figured out that it would not make much difference to their long-term well-being, and therefore did not change their spending habits much.
24 The Extreme Variability of Investment Investment spending is the most volatile of all spending components.Volatility caused in part by sudden changes in business confidence.
25 The Determinants of Net Exports Our imports rise when our GDP rises and fall when our GDP falls.Our exports are relatively insensitive to our own GDP, but are directly related to GDPs of our trading partners.Our exports rise when our prices fall and vice-versa; our imports rise when prices fall in the economies of our trading partners.
26 How Predictable is Aggregate Demand? While the consumption function seems like a simple tool, it is actually quite difficult to predict consumer spending.An activist fiscal policy may not have much effect at all on spending, if people anticipate that taxes will be changed frequently.
28 Defining GDP: Exceptions to the Rules GDP = sum of the money values of all final goods and services produced during a specified period of time
29 Defining GDP: Exceptions to the Rules Government outputs = valued at the cost of the inputs needed to produce themInventories are treated as though they were bought by the firms that produced them, even though these purchases do not really take placeInvestment goods = final products demanded by the firms that hold them
30 GDP as the Sum of Final Goods and Services GDP as the sum of all final demands in one yearSum of expenditures on all final goods and servicesGDP = C + I + G + (X - IM)
32 GDP as the Sum of All Factor Payments GDP as sum of incomes (or factor payments)GDP as the sum of all factor paymentsValue of factors’ outputs = value of incomesGDP = wages + interest + rents + profits + purchases from other firms
34 GDP as the Sum of Values Added GDP = sum of values added to goods in all firmsValue added = firm’s revenue from selling a product minus the amount paid for goods and services purchased from other firms