Basic Macroeconomic Relationships. Topics Income – consumption & saving relationship Interest rate – rate of return – investment The multiplier – very important concept!. $ 13,841 1687 $ 12,154 29 96 $ 12,221 1009 979 467 344 2237 $ 11,659 1482 $ 10,177.
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Income – consumption & saving relationship
Interest rate – rate of return – investment
The multiplier – very important concept!
$ 10,177U.S. Income Relationships 2007
Gross Domestic Product (GDP)
Less: Consumption of Fixed Capital
Equals: Net Domestic Product (NDP)
Less: Statistical Discrepancy
Plus: Net Foreign Factor Income
Equals: National Income (NI)
Less: Taxes on Production and Imports
Less: Social Security Contributions
Less: Corporate Income Taxes
Less: Undistributed Corporate Profits
Plus: Transfer Payments
Equals: Personal Income (PI)
Less: Personal Taxes
Equals: Disposable Income (DI)
Income – Saving Relationship
Any point on the 45 degree
Reference line is equidistant
From each axis (DI = C)
Saving and consumption
Both are directly related to
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APC – average propensity to consume – fraction of income that is consumed. Consumption / Income
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APS – average propensity to save – fraction of income that is saved.
Saving / Income
MPC – marginal propensity to consume – the fraction of any change in
Income that will be consumed. Change in Consumption / Change in Income
MPS – marginal propensity to save – the fraction of any change in
Income that will be saved. change in Saving / change in Income
Saving $5 Billion
Consumption (billions of dollars)
Dissaving $5 Billion
Disposable Income (billions of dollars)
(billions of dollars)
Saving $5 Billion
Selected Nations, with respect to GDP, 2006
.80 .85 .90 .95 1.00
Source: Statistical Abstract of the United States, 2006
Consumption and Saving
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Relationship between real interest rates and investment.
Investment – expenditures on new plants, capital equipment, machinery, inventories, etc.
Investment decision – a MB MC decision.
MB is the expected rate of return businesses hope to realize.
MC is the interest rate that must be paid for borrowed funds.
Business will invest in all projects where expected rate of return exceed the interest rate.
The two basic determinants of investment spending!
Expected Rate of Return, r
Real Interest Rate:
i is the nominal rate adjusted for inflation.
Inverse relationship between Investment demand and the real interest rate.
r and i (percent)
Investment (billions of dollars)
Percent of GDP, Selected Nations, 2006
0 10 20 30
Source: International Monetary Fund
Initial Change in Spending
The Multiplier Spending Effect
(MPC = .25)
(MPC = .75)
Increase in Investment of $5
All other rounds
Rounds of Spending
1 - MPC
The Spending Multiplier Effect
Multiplier Effect and the Marginal Propensities
Inverse relationship between:
Multiplier & MPS
The Multiplier Effect
MPC and the Multiplier
average propensity to consume (APC)
average propensity to save (APS)
marginal propensity to consume (MPC)
marginal propensity to save (MPS)
expected rate of return
investment demand curve