Module 16- Consumption, Income, and the Multiplier (PowerPoint 16A)- Consumption/Saving/Keynesian Expenditure Model J.A.SACCO

Module 16- Consumption & Saving You have two choices when you earn income--you can either consume it or save it. What you do not consume is, by definition, what you save. Saving is important because investment is impossible without it. In the United States, the rate of personal saving has dropped significantly over the past several decades.

Did You Know That... Personal consumption expenditures in the United States have averaged about two-thirds of gross domestic product for decades? John Maynard Keynes focused much of his research on what determines how much you and I decide to spend

Module 16 GOALS Focus on what determines spending and saving Concentrate on the relationship between a persons income and how much they spend (consume) and save Analyze the relationship of consumption, investment, government expenditure, and net exports (GDP) In other words, what causes the changes in GDP? C+I+G+(X-M)

? Why is this important to our study of macroeconomics? Module 16 GOALS Why is this important to our study of macroeconomics? ?

Some Simplifying Assumptions in the Keynesian Income Determination Model Keynes Revisited Equilibrium level of GDP is demand determined Concentrated on elements of desired aggregate expenditures Horizontal SRAS- Keynesian Range so inflation is not possible/no change in price level Since PL is constant, any change in economic variables such as income, will be equal to a real change in terms in purchasing power Hence-Examine Keynes ideas with inflexible prices

Definitions and Relationships Definitions & Relationships Revisited Consumption Spending on new goods and services out of a household’s current income Saving The act of not consuming all of one’s income

Definitions and Relationships Two things you can do with income: Consume It! Gone forever Consumption goods (household purchases for immediate satisfaction—food, clothing, movies, etc…) Save It! Able to consume at a future time and perhaps more with interest

Definitions and Relationships Consumption + Saving= Disposable Income OR Saving= Disposable Income-Consumption

Definitions and Relationships Dissaving- Negative saving. A situation where spending exceeds income. Investment-The spending by business on things which can be used to produce goods and services in the future. Stocks/Flows-A stock is a variable measured at a point in time. A flow is a variable measured over a period of time.

Stocks and Flows Which is a stock? Which is a flow? Saving Savings Consumption Investment

Stocks and Flows Saving- (FLOW)- particular rate-daily monthly, yearly Savings- (STOCK)- certain point in time saving+saving+saving=savings Consumption-(Flow)- related to saving, consume at a certain rate Investment-(Flow)- expenditures by firms on new machinery/equipment-yield future stream of income- “fixed investment”

Classical Economic View of Consumption and Saving Saving is based on the interest rate! Interest rate increases Saving increase Consumption decrease Interest rate decreases Saving decreases Consumption increases

Determinants of Planned Consumption and Planned Saving Keynes Says NO!!! Interest rate not the key to what determines an individuals consumption and saving decisions. Keynes argued that saving and consumption decisions depend primarily on an individual’s real current income.

Determinants of Planned Consumption and Planned Saving Keynes was concerned with changes in AD. If we can determine the reasons and tendencies of consumption and saving, it might be possible to determine the future macroeconomy.

Real Consumption and Saving Schedules: A Hypothetical Case (1) (2) (3) (4) (5) (6) (7) Planned Average Average Real Planned Real Saving Propensity Propensity Marginal Marginal Disposal Real Con- Per Year to Consume to Save Propensity Propensity Income per sumption (S=Yd-C) (APC=C/Yd) (APS=S/Yd) to Consume to Save Combination Year (Yd) per year (C) (1) - (2) (2)/(1) (3)/(1) A $0 B 2,000 C 4,000 D 6,000 E 8,000 F 10,000 G 12,000 H 14,000 I 16,000 J 18,000 K 20,000 $2,000 3,600 5,200 6,800 8,400 10,000 11,600 13,200 14,800 16,400 18,000 $-2,000 -1,600 -1,200 -800 -400 400 800 1,200 1,600 2,000

The Consumption Function and the Keynesian Expenditure Model 20,000 What is the horizontal axis? What does it represent? What is the vertical axis? What does it represent? What is the consumption function? What is the 45 degree line? What does it represent? What is autonomous consumption? What does it represent? What is disposable income, consumption, and savings at points A, C, F, I? What is the break-even point? What does it represent? What happens to consumption and saving as real disposable income increases? 16,000 12,000 Planned Real Consumption (C, dollars per year) 8,000 4,000 2,000 4,000 8,000 12,000 16,000 20,000 Real Disposable Income (Yd dollars per year)

The Consumption Function and the Keynesian Expenditure Model C=Yd 450 20,000 Consumption function Saving A B C D E F G H I J K 16,000 12,000 Break-even income Planned Real Consumption (C, dollars per year) 8,000 4,000 Dissaving 2,000 Autonomous consumption 4,000 8,000 12,000 16,000 20,000 Real Disposable Income (Yd dollars per year)

Determinants of Planned Consumption and Planned Saving Causes of Shifts in the Consumption Function. Non-income determinants of consumption. Population- Increase consumption- function upward. Expectations- Better times upward/worse times downward. Wealth- Increase real household wealth upward/decrease downward. Can you think of other non-income determinants of consumption?

Determinants of Planned Consumption and Planned Saving Household Debt- Can increase consumption with borrowing or more debt. However as accumulate more debt, need to use more disposable income to pay off debt thus decreasing consumption. Inflation- Inflation down/upward, inflation up/downward. Taxes/Transfer Payments- more taxes C and S down/ less taxes C and S up. More transfer payments both C and S up, less C and S down.

The Consumption Function Y2 C2 C1 Assume positive economic expectations Planned Real Consumption (C, dollars per year) C1 Y1 Real Disposable Income (Yd dollars per year)

The Consumption Function Planned Real Consumption (C, dollars per year) C1 Y1 C2 Y2 Assume wealth decreases Real Disposable Income (Yd dollars per year) Y2

The Consumption and Saving Functions Therefore an upward shift in consumption tells us that at all levels of disposable income, consumption is greater. If consumption is greater at all levels of disposable income, saving must be lower., and vice-versa. The only exception is taxes and transfer payments (both move in the same direction).