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Income Consumption and Saving. Consumption and saving Primarily determined by Disposable Income Direct relationship – as DI increases, so does consumption. Saving is what’s left over, what’s not spent.

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income consumption and saving
Income Consumption and Saving
  • Consumption and saving
    • Primarily determined by Disposable Income
    • Direct relationship – as DI increases, so does consumption.
    • Saving is what’s left over, what’s not spent.
    • Households spend a higher percentage of a small disposable income than of a large disposable income.

Important – This is all IN THE AGGREGATE. It does not represent each individual household, or even any individual household. It is all households combined, according to studies done by economists

27-1

LO1

consumption and saving schedules1

500

475

450

425

400

375

45°

50

25

0

  • 390 410 430 450 470 490 510 530 550
Consumption and Saving Schedules

C

Saving $5 billion

Consumption

schedule

Consumption (billions of dollars)

Dissaving $5 billion

  • 390 410 430 450 470 490 510 530 550

Dissaving

$5 billion

Saving schedule

S

Saving

(billions of dollars)

Saving $5 billion

Disposable income (billions of dollars)

27-4

LO1

average propensities
Average Propensities
  • Average propensity to consume (APC)
    • Fraction of total income consumed
  • Average propensity to save (APS)
    • Fraction of total income saved

consumption

saving

APC =

APS =

income

income

APC + APS = 1

27-5

LO1

marginal propensities
Marginal Propensities
  • Marginal propensity to consume (MPC)
    • Proportion of a change in income consumed
  • Marginal propensity to save (MPS)
    • Proportion of a change in income saved

change in consumption

change in saving

MPC =

MPS =

change in income

change in income

MPC + MPS = 1

27-7

LO1

marginal propensities1
Marginal Propensities

C

5

20

15

20

MPC =

= .75

Consumption

C ($15)

DI ($20)

S

MPS =

= .25

Saving

S ($5)

DI ($20)

Disposable income

27-8

LO1

nonincome determinants
Nonincome Determinants
  • Amount of disposable income is the main determinant
  • Other determinants
    • Wealth
    • Expectations
    • Real interest rates
    • Household Debt
    • Taxation – the only one that shifts both consumption and saving in the same direction.

27-9

LO2

shifts of c s schedules

45°

Shifts of C & S Schedules

C1

C0

C2

Consumption

(billions of dollars)

0

S2

S0

+

S1

Saving

(billions of dollars)

0

-

Disposable Income (billions of dollars)

27-10

LO2

interest rate investment
Interest-Rate-Investment
  • Expected rate of return and the real interest rate.
    • If the expected rate of return is greater than the real interest rate, then the firm should undertake the investment.
    • Applies to borrowing or to cash on hand.

27-11

LO3

investment demand curve

16

14

12

10

8

6

4

2

0

Expected rate of return, r

and real interest rate, i (percents)

5 10 15 20 25 30 35 40

Investment (billions of dollars)

Investment Demand Curve

Investment

demand

curve

ID

27-12

LO3

shifts of investment demand
Shifts of Investment Demand
  • Acquisition, maintenance, and operating costs
  • Business taxes
  • Technological change
  • Stock of capital goods on hand
  • Planned inventory changes
  • Expectations

27-13

LO4

shifts of investment demand1
Shifts of Investment Demand

Increase

in investment

demand

Expected rate of return, r, and

real interest rate, i (percents)

Decrease in

investment

demand

ID1

ID0

ID2

0

Investment (billions of dollars)

27-14

LO4