Aggregate Expenditure and Equilibrium Output

1. Aggregate Expenditure and Equilibrium Output Consumption 1

2. What Determines the Level of Consumption? Consumption 2

3. The Role of Income • Disposable Income: The current income you receive in your paycheck, after you pay taxes. • Expected Future Income: The income you expect to receive in the future 3

4. The Role of Income • Disposable Income: The current income you receive in your paycheck, after you pay taxes. • Expected Future Income: The income you expect to receive in the future Higher Consumption Higher Income 4

5. Income = Consumption + Savings + TaxesY = C + S + T Taxes Savings Income Consumption 5

6. Consumption Schedule Income 0 1000 2000 3000 4000 Consumption 500 1250 2000 2750 3500 Assuming Taxes=0 6

7. Consumption Schedule Income 0 1000 2000 3000 4000 Consumption 500 1250 2000 2750 3500 Saving -500 -250 0 250 500 + = 7

8. EXAM TYPE QUESTION T F Consumption plus disposable income is equal to savings. The statement is “FALSE” 8

9. Consumption 4000 3000 2000 1000 9

10. Consumption 4000 3000 2000 1000 1000 2000 3000 4000 Household Income 10

11. Consumption 4000 3000 2000 1000 45o line 1000 2000 3000 4000 Household Income 11

12. Consumption 5000 4000 Con- sumption 3000 2000 1000 45o 0 0 1000 2000 3000 4000 Household Income 12

13. C Slope = Y Consumption C C 45o Y Household Income 13

14. Consumption 5000 5000 5000 C 4000 3000 C=750 Y=1000 2000 1000 Slope = 0.75 0 45o 0 1000 2000 3000 4000 Household Income 14

15. C = 500 + .75*Income • People buy goods even when their income is zero • 75% of each dollar of income is consumed • 25% of each dollar is saved • 0.75 is the Marginal Propensity to Consume (MPC) 15

16. 4 - 3 - 2 - 1 - What is the marginal propensity to consume, MPC, in the figure? 1.00 0.90 0.67 $3 million Consumption expenditure (millions of dollars) Consumption EXAM TYPE QUESTION The correct answer is “c” ' ' ' ' ' 0 1 2 3 4 5 Disposable income (millions of dollars) 16

17. Savings • Savings = Income - Consumption • MPS: marginal propensity to save • MPS = 1 - MPC • C = Ca + MPC ( Y ) • S = Y - C = Y - Ca - MPC ( Y ) • = - Ca + Y ( 1 - MPC ) • = Sa + MPS ( Y ) 17

18. EXAM TYPE QUESTION Consumption expenditure increases when ……………… increases. • the interest rate • the price level • real GDP • saving The correct answer is “c” 18

19. EXAM TYPE PROBLEM __S__ -10 80 170 260 350 Given the following schedule: __DI__ __C__ 100 110 200 120 300 130 400 140 500 150 Formulate the saving function, by setting numerical values where possible. • = Sa + 90/100 ( 200 ) • Sa = 80 - 0.9 ( 200 ) = -100 • S = -100 + 0.9 ( DI ) 19

20. EXAM TYPE QUESTION T F The part of each dollar which is not consumed is not necessarily saved. FALSE 20

21. EXAM TYPE PROBLEM Given the following schedule, DI S 200 10 300 20 400 30 500 40 600 50 Formulate the consumption function, by setting numerical values where possible. • = Ca + 0.9 ( 200 ) • Ca = 190 - 180 = 10 • C = 10 + 0.9 ( DI ) 21

23. EXAM TYPE PROBLEM Saving Saving 30 20 10 Disposable Personal Income 0 100 200 300 400 500 -10 -20 23

24. EXAM TYPE QUESTION The higher the level of income, • The smaller the APS • The greater the APS • The smaller the MPS • The greater the MPS • None of the above The correct answer is “b” 23

25. Exp. Rises C As income rises, what happens to a. The amount consumed? EXAM TYPE QUESTION Y b. The amount saved? S S Rises Y 24

26. As income rises, what happens to c. Proportion of consumption to income? Assume an MPC of 0.9. Assume when income was 800, consumption was 750. APC = 750 ÷ 800 = 0.9375 If income rises by 200, up to 1,000, consumption shall rise by 0.9 x 200 = 180, up to 930. APC’ = 930 ÷ 1,000 = 0.93 < 0.9375 So the proportion of consumption to income falls. 25 d. Proportion of savings to income? MPS = 1 - 0.9 = 0.1 When income was 800, saving was 50. APS = 50 ÷ 800 = 0.0625 If income rises by 200, up to 1,000, saving shall rise by 0.1 x 200 = 20, up to 70. APS’ = 70 ÷ 1,000 = 0.07 > 0.0625 So the proportion of savings to income rises.

27. EXAM TYPE QUESTION If people save a higher proportion of their income than they consume, what type of a relationship can be derived in terms of propensities? APS > APC 26

28. Consumption Consumption Function S Y C 45o Household Income 27

29. Exp. Y1 45º line a C2 C b BE b' YBE 500 C1 a' CBE 0 2000 Y = DI SAVING DISSAVING Y2 S S c Y2 0 YBE Y1 Y = DI 28 c’ -500

30. EXAM TYPE QUESTION The saving function Shows what households plan to save at various income levels. Slopes upward to the right because saving increases as income increases. Has a slope equal to the MPS Can be derived from the consumption function. Is characterized by all of the above. The correct answer is 29 “e”

31. EXAM TYPE QUESTION Positive savings • Show on the diagram, the area of • positive savings. • Are the very poor able to save? Why? • Show a possible income level for the • poor on the diagram, and the level of • savings thereon. The level of dissavings at Y. Y A possible income level for the poor. The very poor are not able to save. Because their income is low, almost enough for them to survive. 30

32. BREAK-EVEN • BREAK-EVEN IS WHEN Y = C DIFFERENTLY SPEAKING, WHEN S = 0 • YBE = C = Ca + MPC ( Y BE ) YBE - MPC ( YBE ) = Ca YBE ( 1 - MPC ) = Ca YBE = ___Ca__ = _Ca_ 1 - MPC MPS • IN OUR EXAMPLE: YBE = 500 = 2,000 0.25 31

33. EXAM TYPE QUESTION Our assumptions concerning consumption and saving include all of the following except: • The MPS and MPC are both positive and less than one • The APC falls as income rises • The APS rises as income rises • The MPC is negative below the break-even level of income The correct answer is “d” 32

34. Increase in MPC An increase in the MPC increases the slope of the consumption function… 33

35. Increase in MPC Consumption Function Consumption 45o Household Income 34

36. Increase in the Constant • An increase in the constant shifts the entire consumption function upward, parallel to the original. • A shift in the consumption function will take place due to a change in one of the exogenous variables of consumption. 35

37. Increase in Constant Consumption Function Consumption 45o Household Income 36

38. EXOGENOUS VARIABLES OF CONSUMPTION • STOCKS OF LIQUID ASSETS • STOCKS OF DURABLE GOODS ON HAND • EXPECTATIONS • CONSUMER INDEBTEDNESS • ATTITUDES TOWARD THRIFT • TAXATION 37

39. STOCKS OF LIQUID ASSETS • LIQUID ASSETS ARE LIKE CASH AND SECURITIES • AS THE STOCKS OF LIQUID ASSETS WITH PEOPLE RISE THROUGHOUT TIME CONSUMERS FEEL MORE SECURE FINANCIALLY THEY CONSUME MORE AND SAVE LESS CONSUMPTION RISES INCOME HELD CONSTANT, SAVING FALLS 38

40. 45º line Exp. C’ BE’ WE RECOGNIZE THAT AS CONSUMPTION RISES, AND SAVING FALLS, ‘‘B.E.’’ CHANGES C BE 0 Y = DI BUT THE PARALLELITY OF ‘‘YBE’’ ON THE TWO DIAGRAMS STAYS S S S’ 0 YBE YBE’ Y = DI 39

41. STOCKS OF DURABLE GOODS ON HAND DURABLE GOODS ARE THOSE GOODS THAT ARE USEFUL FOR LONGER THAN A YEAR AS THE STOCKS OF DURABLE GOODS RISE THE NEED TO BUY ADDITIONAL DURABLE GOODS FALLS CONSUMPTION FALLS, AND SAVING RISES 40

42. EXPECTATIONS PRICES: AS PEOPLE EXPECT PRICES TO RISE IN THE FUTURE, THEY PLAN TO BUY MORE NOW, BEFORE PRICES HAVE RISEN, STORE THE EXCESSIVE GOODS PURCHASED, AND USE THEM IN THE FUTURE, BY THIS THEY AVOID PAYING THE EXPECTED FUTURE HIGH PRICES. CONSUMPTION RISES, SAVING FALLS 41

43. SHORTAGES: AS PEOPLE EXPECT POSSIBLE SHORTAGES IN THE FUTURE, THEY PLAN TO BUY MORE NOW, STORE THE EXCESSIVE GOODS, AND USE THEM IN THE FUTURE, TO AVOID THE PROBLEM OF SHORTAGES CONSUMPTION RISES, SAVING FALLS 42

44. INCOMES: AS PEOPLE EXPECT THEIR INCOMES TO RISE IN THE FUTURE, THEY FEEL SAFER ABOUT THE FUTURE, THEIR NEED FOR SAVING LOSES GROUND, THEY SAVE LESS, SO THEY CONSUME MORE CONSUMPTION RISES, SAVING FALLS 43

45. EXAM TYPE QUESTION If people expect incomes to fall in the future, what shall be the impact of such an expectation upon consumption and savings? Demonstrate graphically. c c’ s’ s 44

46. CONSUMER INDEBTEDNESS AS PEOPLE FIND OUT THAT THEIR INDEBTEDNESS HAS INCREASED THROUGHOUT TIME, THEY PLAN TO SAVE MORE, TO BE ABLE TO SETTLE THEIR DEBTS, SAVING RISES, SO CONSUMPTION FALLS 45

47. ATTITUDES TOWARD THRIFT AS A SOCIETY BECOMES MORE THRIFTY, PEOPLE PLAN TO SAVE MORE, SO TO CONSUME LESS, CONSUMTPION FALLS, SAVING RISES 46

48. TAXATION DI = Y - T AS TAXATION RISES, DI FALLS DI = C + S AS DI FALLS, CONSUMPTION FALLS AND SAVING FALLS 47

49. 45º line Exp. WE RECOGNIZE THAT THE PARALLELITY OF “YBE” ON THE TWO DIAGRAMS HAS BEEN VIOLATED. C C’ BE BE’ 0 YBE’ Y = DI S S S’ 0 YBE YBE’ Y = DI 48

50. EXAM-TYPE QUESTION A reduction in personal income taxes is likely to cause which of the following changes in the components of total spending? • Increased consumption • Increased investment • Decreased government expenditures • Increased exports • Decreased imports 49 The correct answer is “a”