Expenditure Chapter 12

Four Components of Expenditure Personal Consumption Expenditure Government Consumption Expenditure Investment Net Exports Consumption, Investment, and Net Exports are determined in the private sector.

Categories of Spending BEA NIPA Table 2.3.5

Consumption in HK Four consumption categories 1.Food 2.Non-Durables: Clothes, Toys 3.Durables: White Goods, Electronics 4.Services: Health, Rental Source: CEIC Database

HK Personal Consumption Expenditure

HK Short-term: Year to year growth Theory of consumption best explains non-durables, services and food consumption. HK NIPA Table 038HK NIPA Table 038

Gross Domestic Investment ( and Components) BEA NIPA Table 5.2.5

Investment HK, 2007

Volatility: Investment and GDP Annual Growth Rates

Government Consumption Expenditure: Hong Kong

Consumption and Disposable Income Many households live paycheck to paycheck and will spend money as it comes in. Thus, consumption is a function of disposable income which increases with income.

Factors Affecting the Level of Autonomous Consumption Spending Personal taxes Real interest rate Consumer confidence Existing stock of wealth –Strongly affected by stock and RE prices Availability of consumer credit Stock of consumer debt outstanding 6/25/2015 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 13

Investment and Cash Flow Financial Accelerator Effect: Download When business cycle conditions improve, business cash flow also improves. Businesses, especially those without access to financial markets, rely on cash flow for financing.Download

Determinants of Gross Private Domestic Investment Level of real income and output in the economy Real interest rates Business taxes Expected Profits and Business Confidence Capacity utilization rates Residential Investment Spending Inventory Investment 6/25/2015 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 15

Multiplier Effect in the Open Economy Multiplier feedback is moderated by international trade. Some of the extra expenditure generated by extra income/cash flow will be spent on imports and thus not generate extra demand for domestic goods. Multiplier effect smaller in economies that spend a high fraction of their income on imported goods.

Expenditure Function E0E0 AutonomousExpenditure 1 E Y

Expenditure is a Feedback Loop Expenditure is determined by household and corporate income. Income is determined by the value added of output in the economy. Output will be determined by demand for expenditure. Y=E

Equilibrium Expenditure E0E0 E Y Y=E YDYD

Disequilibrium Level Income and Output Adjustment Relationship of E to YInventoriesOutput Adjustment E > Y Unexpected decrease in inventories Output increases E = Y Inventories are at expected level Output equilibrium E < Y Unexpected increase in inventories Output decreases 6/25/2015 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 20

Multiplier Effect Changes in autonomous expenditure will have multiple impacts on output. The higher is the marginal propensity to consume or invest, the larger is that multiple. The more open is the economy, the smaller is that multiple.

Multiplier Effect (if mpinv,mpim=0) Income Production Savings Consumption

Multiplier Effect 2 Income Production Savings Consumption

Multiplier Effect 3 Income Production Savings Consumption

Multiplier Effect: Open Economy Income Production Savings Consumption Imports

Interest and Autonomous Expenditure There is negative relationship between the real interest rate and consumption and expenditure. Real interest rate, r, is: –the direct cost of financing corporate investment, housing, or consumer durables. –the return on saving and thus the opportunity cost of consumption.

Interest Sensitive Autonomous Expenditure Define as the part of expenditure which is interest sensitiv and NIRE as the non- interest sensitive component. Autonomous expenditure is a negatively related to the real interest rate. This means that equilibrium expenditure is negatively related to expenditure

Consider r 2 < r 1 E 0 (r 1 ) E Y Y=E Y D (r 1 ) E 0 (r 2 )

Learning Outcomes Students should be able to name the main components of expenditure and their determinants. Students should be able to calculate equilibrium expenditure as a multiple of autonomous expenditure. Use the model of equilibrium expenditure to explain the effect of events on demand for goods.