Slide Show #4 AGEC 430 Macroeconomics of Agriculture Spring 2010

Handout #4

GDP = C + I + G + X – M where: C = consumption expenditures I = investment expenditures G = government expenditures X = exports M = imports Consumption represents 70% of GDP

Annual level of personal consumption expenditures. Represents 70 percent of our nation’s GDP.

Annual percent change in personal consumption expenditures. This graph highlights the recent downturn in C relative to recent recessions.

The simple consumption function originally formulated by Keynes back in the late 1930s.

Quarterly level of disposable personal income. The is the Y – T variable in the consumption function on the previous page.

The slope of the consumption function is known as the marginal propensity to consume.

Personal saving rate.

∆C / ∆(Y – T)

Real wealth effect can be inflationary as we saw in 1990s. What about recent years? Real wealth effect can be inflationary as we saw in 1990s. What about recent years?

Why is this concept important?

A one-time spike in disposable income or “transitory income” will do little to change consumption behavior since it is not expected to continue.

Age 25Age 45Age 65 = T N – T at age 45 Peak earnings Lifetime Earnings Cycle Savings rate lowSavings rate rising

We can Graph these relationships

Planned Consumption Function The consumption function in this graph can be expressed graphically as shown below. The consumption function in this graph can be expressed graphically as shown below. C = A C + b 1 (Y - T)

Autonomous or fixed consumption Autonomous or fixed consumption Planned Consumption Function The slope of the consumption function is the marginal propensity to consume (MPC), or  C /  (Y – T) The slope of the consumption function is the marginal propensity to consume (MPC), or  C /  (Y – T)

Consumer expenditures would be $3,600 if disposable income was equal to $3,000. Consumers would be dis-saving by $600. Consumer expenditures would be $3,600 if disposable income was equal to $3,000. Consumers would be dis-saving by $600. Planned Consumption Function C = $1, ($3,000) = $3,600

An increase in disposable income to $4,000 would raise expenditures to $4,300. Dis-saving would fall to $300. An increase in disposable income to $4,000 would raise expenditures to $4,300. Dis-saving would fall to $300. Planned Consumption Function C = $1, ($4,000) = $4,300

An increase in disposable income to $5,000 would raise expenditures to $5,000. Dis-saving would fall to zero. An increase in disposable income to $5,000 would raise expenditures to $5,000. Dis-saving would fall to zero. Planned Consumption Function C = $1, ($5,000) = $5,000

A role for fiscal policy here: A cut in the tax rate increases consumption. An increase in the tax rate decreases consumption. A role for fiscal policy here: A cut in the tax rate increases consumption. An increase in the tax rate decreases consumption. Planned Consumption Function

A role for fiscal policy here: A cut in the tax rate increases consumption. An increase in the tax rate decreases consumption. A role for fiscal policy here: A cut in the tax rate increases consumption. An increase in the tax rate decreases consumption. Planned Consumption Function

Real Wealth Effect Suppose stock market prices rose, increasing real wealth of consumers by $700. Suppose stock market prices rose, increasing real wealth of consumers by $700.

Real Wealth Effect This would increase the intercept by $700, This would increase the intercept by $700,

Real Wealth Effect C = $1,500 + $ ($4,000) = $5,000 This shifts the curve upward for given income level, boosts consumer spending to $5,000. This raises dis-saving to $1,000, raising debt relative to income, and can be inflationary….. This shifts the curve upward for given income level, boosts consumer spending to $5,000. This raises dis-saving to $1,000, raising debt relative to income, and can be inflationary…..

Annual percent change in personal consumption expenditures. Given our discussion thus far, what has caused consumption to decline so sharply?