After reading this chapter, you should be able to: Describe how changes in income affect consumption (and saving), list and explain factors other than income that can affect consumption, explain how changes in real interest rates affect investment, identify and explain factors other than the real interest rate that can affect investment, illustrate how changes in investment increase or decrease real GDP by a multiple amount. | Basic Macroeconomic Relationships 27 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Income Consumption and Saving Consumption and saving Primarily determined by DI Direct relationship Consumption schedule Planned household spending (in our model) Saving schedule DI minus C Dissaving can occur LO1 27- Income Consumption and Saving LO1 27- Consumption and Saving Schedules 390 410 430 450 470 490 510 530 550 C S Consumption schedule Saving schedule Saving $5 billion Dissaving $5 billion Dissaving $5 billion Saving $5 billion Consumption (billions of dollars) Saving (billions of dollars) Disposable income (billions of dollars) LO1 27- Average Propensities Average propensity to consume (APC) Fraction of total income consumed Average propensity to save (APS) Fraction of total income saved APC = APS = consumption income income saving APC + APS = 1 LO1 27- Marginal Propensities Marginal propensity to consume (MPC) Proportion of a change in income consumed Marginal propensity to save (MPS) Proportion of a change in income saved MPC = MPS = change in consumption change in income change in income change in saving MPC + MPS = 1 LO1 27- Nonincome Determinants Amount of disposable income is the main determinant Other determinants Wealth Borrowing Expectations Real interest rates LO2 27- Interest-Rate-Investment Expected rate of return The real interest rate Investment demand curve LO3 27- Investment Demand Curve ID (r) and (i) Investment (billions of dollars) 16% $ 0 14 5 12 10 10 15 8 20 6 25 4 30 2 35 0 40 Investment demand curve LO3 27- Shifts of Investment Demand Acquisition, maintenance, and operating costs Business taxes Technological change Stock of capital goods on hand Planned inventory changes Expectations LO4 27- Shifts of Investment Demand Expected rate of return, r, and real interest rate, i (percents) 0 Investment (billions of dollars) ID0 ID1 ID2 Increase in investment demand Decrease in investment demand LO4 27- Global Perspective LO4 27- The Multiplier Effect A change in spending changes real GDP more than the initial change in spending Multiplier = change in real GDP initial change in spending Change in GDP = multiplier x initial change in spending LO5 27- Multiplier and Marginal Propensities Multiplier and MPC directly related Large MPC results in larger increases in spending Multiplier and MPS inversely related Large MPS results in smaller increases in spending Multiplier = 1 1- MPC Multiplier = 1 MPS LO5 27-
