1. 8
Basic
Macroeconomic
Relationships

2. Chapter Objectives
How Changes in Income Affect Consumption (and Saving)
About Factors Other Than Income That Can Affect Consumption
How Changes in Real Interest Rates Affect Investment
About Factors Other Than the Real Interest Rate That Can Affect Investment
Why Changes in Investment Increase or Decrease Real GDP by a Multiple Amount

3. Basic Relationships Income-Consumption Income-Saving 45° Line
C = DI on the Line
S = DI - C

4. Income and Consumption
Consumption and Disposable Income, 83 86 85 84 88 89 91 90 87 92 93 94 95 01 97 96 99 98 00 02 05 03 04
45° Reference Line
C=DI C
Saving
In 1992
Consumption (billions of dollars)
Consumption
In 1992
45°
Disposable Income (billions of dollars)

5. Consumption and Saving
The Consumption Schedule
The Saving Schedule
Break-Even Income
Average Propensity to Consume (APC)
Average Propensity to Save (APS)
O 8.1
APC =
Consumption
Income
APS =
Saving
Income

6. Consumption and Saving
Marginal Propensity to Consume (MPC)
Marginal Propensity to Save (MPS)
MPC =
Change in Consumption
Change in Income
MPS =
Change in Saving
Change in Income

7. Consumption and Saving
(1)
Level of
Output
And
Income
(GDP=DI)
(2)
Consump-
tion
(C)
(3)
Saving (S)
(1-2)
(4)
Average
Propensity
to Consume
(APC)
(2)/(1)
(5)
to Save
(APS)
(3)/(1)
(6)
Marginal
(MPC)
Δ(2)/Δ(1)
(7)
(MPS)
Δ(3)/Δ(1)
$370
390
410
430
450
470
490
510
530
550
$375
390
405
420
435
450
465
480
495
510
$-5 5 10 15 20 25 30 35 40
1.01
1.00
.99
.98
.97
.96
.95
.94
.93
-.01
.00
.01
.02
.03
.04
.05
.06
.07
.75
.25

8. Consumption and Saving
Consumption and Saving Schedules
500
475
450
425
400
375
45° C
Saving $5 Billion
Consumption
Schedule
Consumption (billions of dollars)
Dissaving $5 Billion
Disposable Income (billions of dollars) 50 25
Dissaving
$5 Billion
Saving Schedule
(billions of dollars)
Saving S
Saving $5 Billion

9. Consumption and Saving
GLOBAL PERSPECTIVE
Average Propensities to Consume
Select Nations GDPs
Average Propensities to Consume
United States
Canada
United Kingdom
Japan
Germany
Netherlands
Italy
France
.963
.958
.953
.942
.896
.893
.840
.833
Source: Statistical Abstract of the United States, 2006

10. Consumption and Saving
MPC + MPS = 1
MPC and MPS as Slopes
Nonincome Determinants of Consumption and Saving
Wealth Effect
Expectations
Real Interest Rates
Household Debt
W 8.1

11. Consumption and Saving
Other Important Considerations
Changes Along Schedules
Switch to Real GDP
Schedule Shifts
Stability
Taxation
G 8.1

12. Consumption and Saving
Consumption and Saving Schedules C1
45° C0 C2
Consumption (billions of dollars)
Disposable Income (billions of dollars) S2
(billions of dollars)
Saving S0 S1

13. Interest Rate and Investment
Expected Rate of Return (r)
The Real Interest Rate (i)
Meaning of r = i
Investment Demand Curve
O 8.2
G 8.2

14. Interest Rate and Investment
The Investment Demand Curve
Expected
Rate of
Return (r)
Cumulative
Amount of
Investment
Having This
Return or Higher
(i)
r and i (percent) 16 14 12 10 8 6 4 2
Investment (billions of dollars)
16%
14%
12%
10% 8% 6% 4% 2% 0%
$ 0 5 10 15 20 25 30 35 40 ID

15. Interest Rate and Investment
Shifts of the Investment Demand Curve
Acquisition, Maintenance, and Operating Costs
Business Taxes
Technological Change
Stock of Capital Goods on Hand
Expectations

16. Interest Rate and Investment
Shifts in the Investment
Demand Curve
Increase in
Investment Demand
r and i (percent)
Decrease in
Investment Demand
ID2
ID0
ID1
Investment (billions of dollars)

17. Interest Rate and Investment
Instability of Investment
Durability
Irregularity of Innovation
Variability of Profits
Variability of Expectations

18. Interest Rate and Investment
GLOBAL PERSPECTIVE
Gross Investment Expenditures as a
Percent of GDP, Select Nations
Percent of GDP, 2004
South Korea
Japan
Mexico
Canada
France
United States
Germany
United Kingdom
Sweden
Source: World Bank

19. Interest Rate and Investment
The Volatility of Investment
Gross Investment
Percentage Change
GDP
Year

20. The Multiplier Effect -or- Multiplier = Multiplier = Multiplier =
W 8.2
Change in Real GDP
Initial Change in Spending
Multiplier =
The Multiplier and the Marginal Propensities 1
1 - MPC
Multiplier =
-or- 1
MPS
Multiplier =
Graphically…

21. The Multiplier Effect Tabular and Graphical Views $ 20.00 $ 15.00
(2)
Change in
Consumption
(MPC = .75)
(3)
Change in
Saving
(MPC = .25)
(1)
Change in
Income
Increase in Investment of $5
Second Round
Third Round
Fourth Round
Fifth Round
All other rounds
Total
$ 5.00
3.75
2.81
2.11
1.58
4.75
$ 20.00
$ 3.75
2.81
2.11
1.58
1.19
3.56
$ 15.00
$ 1.25
.94
.70
.53
.39
1.19
$ 5.00
$20.00
$4.75
15.25
$1.58
13.67
$2.11
11.56
$2.81
8.75
ΔI=
$5 billion
$3.75
5.00
$5.00 1 2 3 4 5
All
Rounds of Spending

22. The Multiplier Effect The MPC and the Multiplier MPC Multiplier .9 10.8 5
.75 4
.67 3 .5 2

23. Squaring the Economic Circle
Last
Word
Humorist Art Buchwald and the Multiplier
One Person Can’t Buy a Product
Others Subsequently Impacted and Cannot Buy Other Items
Multiple Effects Impact Psyche
Ultimately Causes Multiple Step Impact Upon the Economy as a Whole

24. Key Terms 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

25. Next Chapter Preview…
The Aggregate
Expenditures Model
Chapter 9!