1. © Oxford University Press, 2005. All rights reserved. Burda & WyploszMACROECONOMICS4 th edn Chapter 6 Private Sector Demand: Consumption and Investment

2. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Variability of GDP Components, 1970-2001 Figure 6.1 Fig. 6.01

3. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.2(a) Consumption tomorrow 0 Indifference curves: Normal case Consumption today Fig. 6.02(a)

4. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.2(b) Consumption tomorrow 0 Indifference curves: Zero substitution Consumption today Fig. 6.02(b)

5. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.2(c) Consumption tomorrow 0 Indifference curves: Constant substitution Consumption today Fig. 6.02(c)

6. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.3(a) Consumption tomorrow 0 Optimal consumption: borrower IC 1 IC 2 IC 3 B D R C1C1 C2C2 M Y1Y1 Y2Y2 (i) (i)Consumption today financed on credit (ii) (ii)Consumption loan repayment (including interest) Fig. 6.03 -(1+r) Consumption today

7. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.3(b) Consumption tomorrow 0 Optimal consumption: lender A Y1Y1 Y2Y2 B IC 1 IC 2 IC 3 D R C1C1 C2C2 (i) (i)Saving from this period’s income (ii) (ii)Additional consumption next period Fig. 6.03 Consumption today -(1+r)

8. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Borrowing Saving Figure 6.4 Time Income, Consumption 0 Life-cycle consumption Income Consumption Permanent income Fig. 6.04

9. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.5 Temporary vs. permanent income change Consumption tomorrow 0 R´ A´´  R´´ Y1Y1 Y2Y2 Y1´Y1´B D A=R A´ B´B´´ D´ Temporary: R to R´ Permanent: R to R´´ Fig. 6.05 Consumption today Y2´Y2´

10. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Real GDP and retail sales growth: Czech Republic, 1997-2002 Figure 6.6 Fig. 6.06

11. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.7 Real price of crude oil, 1956-2002 Fig. 6.07

12. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.8 Current accounts in three countries, 1956-2002 Fig. 6.08

13. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.9 Effect of an increase in the interest rate: negative income effect for borrowers, positive for lenders (a) Student Crusoe (borrower) (b) Professional athlete (lender) Consumption today Consumption tomorrow Consumption today Consumption tomorrow B´ B D B D A A R R R´ Fig. 6.09

14. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Fig. 6.10 Consumption, wealth and disposable income: France, 1980-2002 Fig. 6.10

15. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.11 Consumption tomorrow 0 With a credit constraint, the choice set is reduced. D C B A R Fig. 6.11 Consumption today

16. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.12 GDP, domestic demand and the current account: Poland and East Germany Fig. 6.12

17. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.13 Marginal productivity of capital Output MPK R Marginal cost of capital Fig. 6.13 Output Capital stock Optimal capital stock

18. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.14 Technological progress makes more output possible with the same capital stock. Desired capital stock increases. Marginal productivity of capital Output R MPK´ New Old MPK Fig. 6.14 Output Capital stock

19. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.15 The q-theory of investment Tobin’s q Investment 0 1 Fig. 6.15

20. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.16(a) Investment and Tobin’s q: Inter-war Germany Fig. 6.16(a)

21. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.16(b) Investment and Tobin’s q: Modern Germany Fig. 6.16(b)

22. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.17 Tobin’s q=1 in a world of no adjustment costs (a) Present value of MPK, cost of capital 1 MPK 1 MPK=Marginal return of new investment C If there were no costs of adjustment, the present value of the marginal cost of capital would be independent of the investment rate. Note if there were no depreciation, the investment rate, I/K, =  K/K, the rate of change of the capital stock. Fig. 6.17 Investment rate (I/K)

23. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.17 Tobin’s q when adjustment costs are significant (a) Present value of MPK, cost of capital 1 Marginal cost of investment MPK 1 C However the faster we try to install new capital, the more it adds to the cost of that capital. “Haste makes waste.” Hence the upward slope of the marginal cost of investment with respect to the investment rate. Fig. 6.17 Investment rate (I/K) MPK=Marginal return of new investment A

24. Burda & WyploszMACROECONOMICS 4/e © Oxford University Press, 2005. All rights reserved. Figure 6.17 Tobin’s q (b) Present value of MPK, cost of capital A 1 Marginal cost of investment MPK 1 MPK 2 B With the investment rate corresponding to the rate at point A, in the following period there will be more capital and a lower MPK. The investment rate next period will fall too (as will Tobin’s q), ultimately heading toward a value of unity and no more investment. Fig. 6.17 Investment rate (I/K) MPK=Marginal return of new investment