© oxford university press, 2005. all rights reserved. burda & wyploszmacroeconomics4 th edn...

© Oxford University Press, 2005. All rights reserved.

Burda & Wyplosz MACROECONOMICS 4th edn

Chapter 6

Private Sector Demand:Consumption and

Investment


Burda & Wyplosz MACROECONOMICS 4/e

Variability of GDP Components, 1970-2001

0%

2%

4%

6%

8%

10%

12%

14%

C/Y I/Y G/Y

Consumption Investment GovernmentConsumption

USA

euro area

Fig. 6.01



Con

sum

ptio

n to

mor

row

0

Indifference curves: Normal case

Consumption today

Fig. 6.02(a)



Con

sum

ptio

n to

mor

row

0

Indifference curves: Zero substitution

Consumption today

Fig. 6.02(b)



Con

sum

ptio

n to

mor

row

0

Indifference curves: Constant substitution

Consumption today

Fig. 6.02(c)



Con

sum

ptio

n to

mor

row

0

Optimal consumption: borrower

IC1

IC2

IC3

B

D

R

C1

C2

M

Y1

Y2

(i)

(i) Consumption today financed on credit

(ii) (ii) Consumption loan repayment (including interest)

Fig. 6.03

-(1+r)

Consumption today



Con

sum

ptio

n to

mor

row

0

Optimal consumption: lender

A

Y1

Y2

B

IC1

IC2

IC3

D

R

C1

C2

(i)

(i) Saving from this period’s income

(ii)

(ii) Additional consumption next period

Fig. 6.03

Consumption today

-(1+r)



Borrowing

Saving

Time

Income,Consumption

0

Life-cycle consumption

Income

ConsumptionPermanentincome

Fig. 6.04



Temporary vs. permanent income changeC

onsu

mpt

ion

tom

orro

w

0

R´

A´´R´´

Y1

Y2

Y1´ B

D

A=R A´

B´ B´´

D´

Temporary: R to R´

Permanent: R to R´´

Fig. 6.05

Consumption today

Y2´



Real GDP and retail sales growth:Czech Republic, 1997-2002

Fig. 6.06

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

Q 1/1997 Q 1/1998 Q 1/1999 Q 1/2000 Q 1/2001 Q 1/2002

Gro

wth

in

re

al

GD

P a

nd

sa

les

(% p

er

an

nu

m)

Retail sales real GDP



Real price of crude oil, 1956-2002

Fig. 6.07

0

50

100

150

200

250

300

350

400

450

1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000

Ind

ex (

1995

=10

0)



-6

-4

-2

0

2

4

6

8

1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000

Netherlands

Denmark

United Kingdom

Current accounts in three countries, 1956-2002

Fig. 6.08



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

Con

sum

ptio

n to

mor

row

Consumption todayC

onsu

mpt

ion

tom

orro

w

B´ B

D

B

D

B´

A

A

R R

R´

R´

Fig. 6.09



300

400

500

600

700

800

900

1000

1100

1200

1300

1000 3000 5000 7000 9000

Net wealth (Euro bn.)

Co

ns

um

pti

on

( E

uro

bn

.)

300

400

500

600

700

800

900

1000

1100

1200

1300

400 600 800 1000 1200 1400

Disposable income (Euro bn.)

Co

ns

um

pti

on

(E

uro

bn

.)

Consumption, wealth and disposable income:France, 1980-2002

Fig. 6.10



Con

sum

ptio

n to

mor

row

0

With a credit constraint, the choice set is reduced.

D

C

B

A

R

Fig. 6.11

Consumption today



GDP, domestic demand and the current account:Poland and East Germany

Fig. 6.12



Marginal productivity of capital

Output

= 1+rslope

MPK

R

K

K

Marginal cost of capital1+r

Y=F K( )

K

K

Fig. 6.13

Output

Capital stock

Capital stock

Optimalcapital stock



Technological progress makes more output possible with the same capital stock. Desired capital stock increases.

Marginal productivity of capital

OutputR

= 1+rslope

K

K

MPK´

New

1+r

Old

MPK

K

K

Fig. 6.14

Output

Capital stock

Capital stock



The q-theory of investment

Tobin’s q

Inve

stm

ent

01

Fig. 6.15



Investment and Tobin’s q:Inter-war Germany

Fig. 6.16(a)

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

1925:01 1927:01 1929:01 1931:01 1933:01 1935:01

Year

Ind

ex

(19

27

=1

00

)

Real stock prices Production of capital goods



Investment and Tobin’s q:Modern Germany

Fig. 6.16(b)

b) Tobin's q and Investment Spending in Germany, 1970-2002

0

50

100

150

200

250

300

350

400

450

500

1970 1974 1978 1982 1986 1990 1994 1998 2002

Year

Inve

stm

en

t (b

n e

uro

s)

0.000

0.500

1.000

1.500

2.000

2.500

3.000

Re

al s

tock

pri

ces

(19

95

=1

.00

)

Real investment Real stock prices



Tobin’s q=1 in a world of no adjustment costs

(a)

Pre

sent

val

ue o

f M

PK

,co

st o

f ca

pita

l

1

I K( )

MPK1

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)



Tobin’s q when adjustment costs are significant

(a)

Pre

sent

val

ue o

f M

PK

,co

st o

f ca

pita

l

1

I K( )I K( )

1q

Marginal cost of investment

MPK1

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



A



Tobin’s q

(b)

Pre

sent

val

ue o

f M

PK

,co

st o

f ca

pita

l

A

1

1I K( )

1q

Marginal cost of investment

MPK1MPK2

2I K( )

2q 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



© oxford university press, 2005. all rights reserved. burda & wyploszmacroeconomics4 th edn...

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