AP Economics Mr. Bernstein Module 16: Income and Expenditure February 2016

AP Economics Mr. Bernstein Income and Expenditure Objectives - Understand each of the following: The nature of the multiplier, which shows how initial changes in spending lead to further changes The meaning of the aggregate consumption function, which shows how current disposable income affects consumer spending How expected future income and aggregate wealth affect consumer spending The determinants of investment spending Why investment spending is considered a leading indicator of the future state of the economy 2

AP Economics Mr. Bernstein The Multiplier: An Informal Introduction Marginal Propensity to Consume (MPC) Marginal Propensity to Save (MPS) MPC =  Consumer Spending /  Disposable Income MPS =  Saving /  Disposable Income MPC + MPS = 1 So MPC = (1 - MPS) and MPS = (1 – MPC) Increase is Y d typically increases both MPC and MPS Real GDP is often represented as Y, Disp. Income as Y d 3

AP Economics Mr. Bernstein The Multiplier: An Informal Introduction, cont. Autonomous Change in Aggregate Spending (AAS)  Y = 1 / (1-MPC) x AAS Multiplier =  Y /  AAS = 1 / (1-MPC) Example?... 4

AP Economics Mr. Bernstein Current Disposable Income and Consumer Spending Consumption Function: C = A + (MPC x Y d ) …(A = Autonomous Consumer Spending = not induced by changes in income) Increase in Y d causes movement upward along C curve Consumption Function Shifters Expected Changes in Future Y d Permanent Income Hypothesis Changes in Aggregate Wealth Life-Cycle Hypothesis 5

AP Economics Mr. Bernstein Investment Spending Most recessions originate in changes in I 6

AP Economics Mr. Bernstein Interest Rates and Investment Spending Decrease in real rates causes increase in I…why? 7

AP Economics Mr. Bernstein Other Factors Influencing Investment Spending Increase in Expected Future GDP or in Production Capacity 8