2. AP MACRO Chapter 9 Basic Macro Relationships

3. Personal Savings=DI- Consumption Factors that Determine Savings DI As DI declines---S declines 45 degree reference line C=DI Savings=amount by which actual C falls short of 45 degree line

5. Consumption Saving o o 45 o C S Consumption schedule Saving schedule C S Disposable Income SAVING DISSAVING MPC = Slope of C MPS = Slope of S MPC + MPS = 1 CONSUMPTION AND SAVING

6. PROPENSITIES APC + APS=1 Consumption/DI Savings/DI MPC + MPS=1 Change in C/Change in DI Change in S/change in DI

7. Non-Income Determinants of C & S 1-wealth Real assets vs. financial assets Usually—if wealth increases-----C moves up; S down 2-expectations Expect recession---- Expect prices to rise tomorrow--- 3-real interest rates If you borrow more---Consume more—save less At low interest rates—less incentive 4-household debt As % of DI Held constant when drawing C schedule If consumers increase debt---increase C more at each level 5-taxes Shift both C and S

8. Consumption Saving o o 45 o C0C0 S0S0 Disposable Income C1C1 S1S1 TERMINOLOGY, SHIFTS, & STABILITY Increases in Consumption Means… A Decrease In Saving

9. Consumption Saving o o 45 o C0C0 S0S0 Disposable Income C2C2 S2S2 TERMINOLOGY, SHIFTS, & STABILITY Decreases in Consumption Means… An Increase In Saving

10. Terminology Change in amount consumed---move pt. to pt Caused by a change in GDP or income Change in determinant Redraw the entire graph

11. Interest rate investment relationship Business—plants/inventory MC=interest rate paid for borrowing Vs. MB=expected rate of return on investment

12. 1st key determinant of Investment Spending 1-expected rate of return=profit Profit/cost Example: Spend $10,000 Make $12,000 net revenue Profit=2,000 2,000/10,000=20% rate of return Rate of return=r

13. 2 nd determinant Real rate of interest (i) Financial cost of borrowing Example: If interest rate is 7% on $10,000 $700 interest cost Compare to expected rate of return $2,000-700=$1300 profit r>i up to the point that r=i

14. Key concerns What if the company is NOT borrowing? Opportunity cost Real interest rate not nominal

15. Investment (billions of dollars) Expected rate of return, r, and interest rate, i (percents) 16 14 12 10 8 6 4 2 0 INVESTMENT DEMAND CURVE 5 10 15 20 25 30 35 40 I D Interest Rate – Investment Relationship

16. What makes Investment Demand Shift? 1-acquisition, maintenance & operating costs 2-business taxes 3-technological change 4-stock of capital goods in hand 5-expectations

17. Investment-most volatile part of GDP 1-durability 2-irregularity of innovation 3-variability of profits 4-variability of expectations