2. Basic Macroeconomic Relationships 9 C H A P T E R

3. 9 - 2 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Income – Consumption and Income – Saving Relationships Personal Saving (S) Consumption (C) Disposable Income (DI) S = DI - C 45-Degree Line The Consumption Schedule The Saving Schedule Break-even Income

4. 9 - 3 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show CONSUMPTION AND SAVING APC Consumption / Income APS Saving / Income MPS Change in Saving Change in Income MPC Change in Consumption Change in Income

5. 9 - 4 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Consumption Saving o o 45 o C S Consumption schedule Saving schedule C S Disposable Income SAVING DISSAVING MPC = Slope of C MPS = Slope of S MPC + MPS = 1 CONSUMPTION AND SAVING

6. 9 - 5 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show.80.85.90.951.0 United States Canada United Kingdom Netherlands Germany Italy Japan France GLOBAL PERSPECTIVE Average Propensities to Consume, Selected Nations, 2000 Statistical Abstract of the United States, 2002

7. 9 - 6 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show NONINCOME DETERMINANTS OF CONSUMPTION AND SAVING Wealth Wealth Effects Expectations Real Interest Rates Household Debt Taxation

8. 9 - 7 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Terminology Schedule Shifts Stability Graphically… TERMINOLOGY, SHIFTS, & STABILITY

9. 9 - 8 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Consumption Saving o o 45 o C0C0 S0S0 Disposable Income C1C1 S1S1 TERMINOLOGY, SHIFTS, & STABILITY Increases in Consumption Means… A Decrease In Saving

10. 9 - 9 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Consumption Saving o o 45 o C0C0 S0S0 Disposable Income C2C2 S2S2 TERMINOLOGY, SHIFTS, & STABILITY Decreases in Consumption Means… An Increase In Saving

11. 9 - 10 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Expected Rate of Return, r Real Interest Rate, i Inverse relationship between Investment demand and the expected rate of return Interest Rate – Investment Relationship Graphically presented...

12. 9 - 11 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Investment (billions of dollars) Expected rate of return, r, and interest rate, i (percents) 16 14 12 10 8 6 4 2 0 INVESTMENT DEMAND CURVE 5 10 15 20 25 30 35 40 I D Interest Rate – Investment Relationship

13. 9 - 12 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Acquisition, Maintenance, and Operating Costs Business Taxes Technological Change Stock of Capital Goods on Hand Expectations SHIFTS IN INVESTMENT DEMAND

14. 9 - 13 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show GLOBAL PERSPECTIVE Gross Investment Expenditures as a Percentage of GDP, Selected Nations 30% 20% 10% 0% GermanyFranceUnited States CanadaMexicoUnited Kingdom SwedenJapanSouth Korea Source: World Bank

15. 9 - 14 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Durability Irregularity of Innovation Variability of Profits Variability of Expectations INSTABILITY OF INVESTMENT

16. 9 - 15 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show INVESTMENT DEMAND & SCHEDULE Expected rate of return, r, and real interest rate, i (percents) Investment (billions of dollars) Investment (billions of dollars) 20 8 Real Domestic Product, GDP (billions of dollars) I D IgIg Investment Demand Curve Investment Schedule 20

17. 9 - 16 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show EQUILIBRIUM GDP GDP = C + I g Real Domestic Output Aggregate Expenditures Schedule Equilibrium GDP Saving and Planned Investment are Equal Leakage Injection No Unplanned Changes in Inventories Actual Investment

18. 9 - 17 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Private spending, C + I g (billions of dollars) o 45 o C C + I g I g = $20 Billion Equilibrium Real domestic product, GDP (billions of dollars) 370 390 410 430 450 470 490 510 530 550 (C + I g = GDP) EQUILIBRIUM GDP C =$450 Billion $530 510 490 470 450 430 410 390 370

19. 9 - 18 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Private spending, C + I g (billions of dollars) o 45 o C C + I g I g = $20 Billion Equilibrium Real domestic product, GDP (billions of dollars) 370 390 410 430 450 470 490 510 530 550 (C + I g = GDP) EQUILIBRIUM GDP C =$450 Billion $530 510 490 470 450 430 410 390 370 Say’s Law

20. 9 - 19 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Private spending, C + I g (billions of dollars) o 45 o C C + I g I g = $20 Billion Equilibrium Real domestic product, GDP (billions of dollars) 370 390 410 430 450 470 490 510 530 550 (C + I g = GDP) EQUILIBRIUM GDP C =$450 Billion $530 510 490 470 450 430 410 390 370

22. 9 - 21 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Change in GDP = Multiplier x initial change in spending Multiplier = or 1 MPS 1 1 - MPC THE MULTIPLIER EFFECT Inverse relationship between: Multiplier & MPS Multiplier Effect and the Marginal Propensities

23. 9 - 22 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show THE MULTIPLIER EFFECT.9.8.75.67.5 10 5 4 3 2 MPCMultiplier MPC and the Multiplier

24. 45-degree line consumption schedule saving schedule break-even income average propensity to consume (APC) average propensity to save (APS) marginal propensity to consume (MPC) marginal propensity to save (MPS) wealth effect expected rate of return investment demand curve multiplier Copyright McGraw-Hill/Irwin, 2005 ENDBACK

25. 9 - 24 Copyright McGraw-Hill/Irwin, 2005 Income – Consumption and Income – Saving Relationships Consumption and Saving Nonincome Determinants of Consumption and Saving Terminology, Shifts, and Stability Investment Shifts in Investment Demand Investment Demand and Schedule Instability of Investment Multiplier Key Terms Previous Slide Next Slide End Show Next... The Aggregate Expenditures Model Chapter 10