Lecture Economics (19/e) - Chapter 27: Basic macroeconomic relationships

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.

27 BasicMacroeconomic Relationships McGrawưHill/Irwin Copyrightâ2012byTheMcGrawưHillCompanies,Inc.Allrightsreserved IncomeConsumptionandSaving Consumption and saving • Primarily determined by DI • Direct relationship • Consumption schedule • Planned household spending (in our • LO1 model) Saving schedule • DI minus C • Dissaving can occur 27-2 Income Consumption and Saving LO1 27-3 Saving (billions of dollars) Consumption (billions of dollars) Consumption and Saving Schedules LO1 C Saving $5 billion Consumption schedule Dissaving $5 billion 370 390 410 430 450 470 490 510 530 550 Dissaving Saving schedule S $5 billion Saving $5 billion Disposable income (billions of dollars) 27-4 Average Propensities • Average propensity to consume (APC) • Fraction of total income consumed • Average propensity to save (APS) • Fraction of total income saved consumption APC = income APS = saving income APC + APS = LO1 27-5 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 = change in consumption change in income MPS = change in saving change in income MPC + MPS = LO1 27-6 Nonincome Determinants • Amount of disposable income is the • LO2 main determinant Other determinants • Wealth • Borrowing • Expectations • Real interest rates 27-7 Interest­Rate­Investment • Expected rate of return • The real interest rate • Investment demand curve LO3 27-8 Investment Demand Curve (r) and (i) 16% LO3 Investment (billions of dollars) $0 14 12 10 10 15 20 25 30 35 40 Investment demand curve ID 27-9 Shifts of Investment Demand • Acquisition, maintenance, and • • • • • LO4 operating costs Business taxes Technological change Stock of capital goods on hand Planned inventory changes Expectations 27-10 Shifts of Investment Demand Expected rate of return, r, and real interest rate, i (percents) Increase in investment demand Decrease in investment demand LO4 ID2 ID0 ID1 Investment (billions of dollars) 27-11 Global Perspective LO4 27-12 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 27-13 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 = LO5 1- MPC Multiplier = MPS 27-14 ... spending (in our • LO1 model) Saving schedule • DI minus C • Dissaving can occur 2 7-2 Income Consumption and Saving LO1 2 7-3 Saving (billions of dollars) Consumption (billions of dollars) Consumption and Saving Schedules... + MPS = LO1 2 7-6 Nonincome Determinants • Amount of disposable income is the • LO2 main determinant Other determinants • Wealth • Borrowing • Expectations • Real interest rates 2 7-7 Interest­Rate­Investment... Investment demand curve LO3 2 7-8 Investment Demand Curve (r) and (i) 16% LO3 Investment (billions of dollars) $0 14 12 10 10 15 20 25 30 35 40 Investment demand curve ID 2 7-9 Shifts of Investment Demand