1. ECO 121 Macroeconomics Lecture Six Aisha Khan Section L & M
Spring 2010
Aisha Khan
Section L & M
Lecture Six

2. Building the Aggregate Model
M&B – Chapter 8
Model developed by John Maynard Keynes
The focus is on the relationship between income and consumption and savings

3. Simplifications Initially we develop a “private closed economy”
Defer complications from govt expenditures and exports/imports
Assume
net foreign factor income = 0
Depreciation = 0
No business saving (gross investment = net investment)

4. Simplifications imply 
Aggregate spending consists of only consumption and investment
GDP = NI = PI = DI

5. Tools of Aggregate Expenditure Theory
Theory assumes that level of output depend directly on Aggregate expenditures
Consumption and saving are the tools
Consumption is the largest component of aggregate spending

6. Consumption
Disposable income  most important determinant of consumer spending
What is not spent is saved
DI - C = S

7. Consumption Schedule Consumption C Consumption Schedule 45 390
Disposable Income

8. Figure conclusions
As disposable income increases  consumption and saving increase
Households consume a large portion of their income
Both consumption and saving are directly related to level of income

9. Consumption schedule
Dissaving occurs at smaller income levels, where consumption exceeds income and households must borrow or use up some of their wealth
Saving schedule

10. Saving Schedule
Saving
Saving Schedule
390
Disposable Income

11. APC and APS Average Propensity to Consume (APC)
Fraction of income which is consumed
APC = consumption/income
Average Propensity to Save (APS)
Fraction of income which is saved
APS = saving/income
APS + APC = 1

12. MPC and MPS Marginal Propensity to Consume (MPC)
Change in consumption due to a change in income
Slope of the consumption schedule
Marginal Propensity to Save (MPS)
Change in saving due to a change in income
MPS + MPC = 1

13. Non-income determinants of C&S
Wealth
Shifts consumption schedule up as it increases
Expectations
Changes in expected inflation and or future wealth
Household Debt
Lower levels shift consumption up
Taxation
Lower taxes  greater consumption schedules

14. Shifts and Stability
Movement along the schedule  changes in amount consumed
Shift of curve  change in consumption schedule
C&S schedules are generally stable

15. Average Propensity to Consume (APC) Average Propensity to Save (APS)
Table
Level of GDP =DI
Consumption (C)
Saving (S)
Average Propensity to Consume (APC)
Average Propensity to Save (APS)
MPC
MPS
370
375 -5
390
410
405 5
430
420 10
450
435 15
470 20
490
465 25
510
480 30
530
495 35
550 40

16. In-class Assignment
What is GDP per capita growth? Why is it a better comparison than GDP growth?
Why is China the most important in the East Asian and Pacific region?
What disadvantage of trade blocs does Europe talk about?
Which region is the worst affected by the Financial Crisis (according to GDP per capita growth)?