1. The Investment Function and Consumption as a Function of Real National Income
J.A.SACCO

2. Consumption Function of Real National Income
We’ve looked at consumption based on the level of RDI per year.
This was an analysis of one person/family
Now must create a consumption function model for entire macroeconomy
Must make adjustments to RDI to RNI (Output)

3. Consumption as a Function of Real National Income
“Y”= Real
National Income
(Output)
45o reference line
AE=Y
45o AE C
C is a function of
real national income.
Assume MPC = .8
2.5
Y axis called
2.0
Where “C” intersects the 45º Line, Consumption
Expenditures equals
Real National Income
*all Income/Output
Consumed
EQUILIBRIUM!
1.5
Planned Consumption per Year
($ trillions)
1.0
Autonomous
consumption
0.5
0.3
0.5
1.0
1.5
2.0
2.5
Real National Income per Year (Output)
($ trillions)
X axis called

4. Keynesian Expenditure Model
Now let’s build the Keynesian macroeconomic model
First must look at “I” component
Historically
Investment has been more volatile than consumption
Why?

5. An Intro to Investments and its Determinants
Starter- What is investment in the context of consumption and GDP?
C+I+G+(X-M)=GDP
Real Consumption
Less variable/more consistent
Consumption expenditures are less subject on how economy looks in future
People will always spend
Real Investment
More variable over time
Based on decisions of business people on variable/subjective elements of economy
Expectations play a role on the investment function-accounts for instability of investment over time.
Large impact on GDP- Change in “I” often affects “C”
Investment depends on interest rate

6. Planned Investment Function
Investment depends on the interest rate
Remember the “Classical Economists”
Interest Rate High/ Investment Low
Interest Rate Low/Investment High
Businesses have an array of investment opportunities with rates of return that are low and some high.
When do you Invest? Investment is profitable if the rate of return is greater than the opportunity cost (interest rate) of the investment.

7. Decision to Invest
The decision of a firm to invest on machinery or construction is simply a decision based upon marginal benefits and marginal costs.
Marginal Benefit of an Investment -is the expected real rate of return (R) the firm anticipates receiving on the expenditure.
Marginal Cost of an Investment- is the real rate of interest (I), or the cost of borrowing.
Rule of Thumb
If Rate of Return% >Real Rate of Interest %, make the investment.
If Rate of Return% < Real Rate of Interest %, don’t make investment.

8. Planned Investment Schedule
Rate of Interest per Year
(percent per year) ($ trillions)
15 .2
14 .3
13 .4
12 .5
11 .6
10 .7
9 .8
8 .9
7 1.0
6 1.1
i% up, Investment down
i% down, Investment up

9. Planned Investment
Just like demand, Investment increases as the price level or in this case the interest rate falls and vice versa! 15 I 14 13 12 11 10
Rate of Interest (percent per year) 9 8 7 6 .1 .2 .3 .4 .5 .6 .7 .8 .9
1.0
1.1
Planned Investment per Year ($ trillions)

10. Non- Interest Rate Determinants of Investment
What Causes the Investment Function to Shift?
When any non-interest rate determinant of investment changes, the investment function (I) will shift.
1) Expectations/ Changes in GDP
2) Productive technology- Need to invest in capital goods to keep up with increased sales
3) Business taxes
*Change of Interest rate will not shift the investment function. You will only move up and down the function.

11. Graphing Changes in Investment/Increase
Positive profit
outlook
Rate of Interest (percent per year) r1 I2 I1 I2
Planned Investment per Year ($ trillions)

12. Graphing Changes in Investment/Decrease
Taxes
Increase
Rate of Interest (percent per year) r1 I1 I2
Planned Investment per Year ($ trillions)

13. Combining Consumption and Investment
The second component of aggregate demand is investment spending, “I".
$700 B. Investment per year is autonomous with respect to real national income. We will assume this investment is constant, regardless of the level of income
I is autonomous
Real Investment per Year
($ trillions) I
0.7 1 2 3 4 5 6 7
Real National Income per Year
($ trillions)

14. Combining Consumption and Investment
6.0
C + I
45o
C + I = Y AE C
5.0
$.7 Trillion
of auto. “I”
4.0
Planned Consumption per Year
($ trillions)
3.0
1) C + I = total planned
expenditures (AE)
2) Equilibrium: C + I = Y
3) Equilibrium Y = $5 trillion
2.0
1.0
0.3
1.0
2.0
3.0
4.0
5.0
6.0
Real National Income per Year (Output)
($ trillions)

15. Keynesian Equilibrium with Government and the Foreign Sector Added
Government (G) - C + I + G
Federal, state, & local
Does not include transfer payments
Is autonomous
Lump-sum taxes
Lump-sum tax
A tax that does not depend on income or the circumstances of the taxpayer
In our model Autonomous Government Spending “G” is $1Trillion dollars

16. Keynesian Equilibrium with Government and the Foreign Sector Added
The Foreign Sector -- C + I + G + X
Net exports (X) = exports - imports
Autonomous
Depends on the economic conditions in each country
In our model Autonomous Net Exports “X”
is $.1 Trillion.

17. The Determination of Equilibrium Real National Income with Net Exports
“G”
“X”
Direction
4+5 Inc. Auto “C” 3-4 Auto Auto Auto of Change
Real Taxes Real Net Exports Total Planned Unplanned in Real
National Disposable Planned Planned Planned Government (exports- Expenditures Inventory National
Income/ Income Consumption Saving Investment Spending imports) (“Y’ axis) Changes Income
Output
(“X” axis) 8
2.0
2.5
3.0
4.0
5.0
6.0
6.5
7.0
8.0
1.0
1.0
1.5
2.0
3.0
4.0
5.0
5.5
6.0
7.0
1.1
1.5
1.9
2.7
3.5
4.3
4.7
5.1
5.9
-.1 .1 .3 .5 .7 .8 .9
1.1 .7
1.0 .1
2.9
3.3
3.7
4.5
5.3
6.1
6.5
6.9
7.7
-.9
-.8
-.7
-.5
-.3
-.1
+.1
+.3
Increase
Neither
Decrease

18. The Equilibrium Level of Real National Income
C + I + G + (X-M)
7.0 AE
RNI < C+I+G+X-M
Less savings/more
consumption causes
shortage. Business
increase output!
AE> I/O E’ C
6.0
RNI > C+I+G+X-M
More savings/ less
consumption causes
surplus. Cut back
Production!
Income/Output > AE.
5.0
Consumption, Investment, Government
Purchases, and Net Exports
($ trillions)
4.0
3.0 I E
1.0
0.3
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
Real National Income/Output per Year (Y)
($ trillions)

19. The Equilibrium Level of Real National Income
Observations
If C + I + G + X (AE) = Y (RNIncome/Output)
Equilibrium
If C + I + G + X (AE) > Y (RNIncome/Output)
unplanned drop in inventories (shortage/negative)
“Negative Unplanned Inventory Investment”
businesses increase output
Y returns to equilibrium
If C + I + G + X (AE) < Y(RNIncome/Output)
unplanned rise in inventories (surplus/positive)
“Positive Unplanned Inventory Investment”
businesses cut output
*Note equilibrium IS NOT full employment/potential of the economy

20. The Equilibrium Level of Real National Income
How does our study of Consumption, Real National Income, and Equilibrium help in Macroeconomics?
The Keynesian Cross