1 chapter 6 consumption & investment 6/10/2015. 2 gdp = c + i + g + ( x – m) gdp = c + i + g gdp =...

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  • Slide 1
  • 1 Chapter 6 Consumption & Investment 6/10/2015
  • Slide 2
  • 2 GDP = C + I + G + ( X M) GDP = C + I + G GDP = C + I
  • Slide 3
  • 3 What determines Consumption Spending? Consumption is a function of income C = f(Y)
  • Slide 4
  • 4 John Maynard Keynes: Author of The General Theory of Employment, Interest and Money
  • Slide 5
  • 5 What was Keynes central idea? An economy can be in equilibrium at less than full employment.
  • Slide 6
  • How did this idea differ from the Classical School view? The Classical Economists believed that the economy is always tending toward a full employment equilibrium
  • Slide 7
  • Keyness View on Consumption: Consumers are guided by the Fundamental Psychological Law comfort zone In terms of consumption, we all strive to achieve a comfort zone. Once we achieve that or are closer to it we do not need to increase our consumption as much with our income as we had done at lower levels of income.
  • Slide 8
  • What is Keynes Absolute Income Hypothesis? As national income increases, consumption spending increases, but by diminishing amounts
  • Slide 9
  • 9 What is MPC? The ratio of the change in consumption spending to a given change in income, that induces it. Change in Consumption Change in Income
  • Slide 10
  • If household's income rises from $12,000 to $12,700 and consumption rises from $13,000 to $13,500, then MPC = $500 / $700 =.71
  • Slide 11
  • According to the Absolute Income Hypothesis, What happens to the Marginal Propensity to Consume as income increases? MPC decreases as income increases and increases as income decreases
  • Slide 12
  • The Consumption Function Real Disposable Income Real Consumption C CC YY 1000 4000 800 3200
  • Slide 13
  • An Individuals Marginal Propensity to Consume
  • Slide 14
  • Slide 15
  • The Individuals Marginal Propensity to Consume 122
  • Slide 16
  • The Nations Marginal Propensity to Consume 123
  • Slide 17
  • 17 Who was Simon Kuznets? He is the author of National Income and Its Composition,...... won Nobel Prize in Economics in 1971 for his pioneering analysis of national income data.
  • Slide 18
  • 18 What did Kuznets conclude about MPC? His empirical research led to the conclusion that MPC tends to remain fairly constant regardless of the absolute level of national income
  • Slide 19
  • The Marginal Propensity to Consume Remains Constant
  • Slide 20
  • Duesenberrys Relative Income Hypothesis: Because social status influences consumption spending, MPC remains constant as long as relative income remains unchanged.
  • Slide 21
  • Autonomous Consumption: u Consumption spending that is independent of the level of income
  • Slide 22
  • The Consumption Function Real Disposable Income Real Consumption C 0 500 Autonomous Consumption
  • Slide 23
  • The Consumption Equation? C = a + bY Autonomous Consumption MPC Income Induced Consumption
  • Slide 24
  • Calculate C for each level of National Income (Y) C = a + bY= 100 +.5(100)= 100= 50 + 100 180 280 400 540 C = a + bY = 60 +.60 (200) = 180C = a + bY = 70 +. 70 (300) = 280C = a + bY = 80 +.80 (400) = 400C = a + bY = 90 +.90 (500) = 540
  • Slide 25
  • National Income Consumption C0C0 C1C1 C2C2
  • Slide 26
  • Will a change in Income cause a shift in C? No! When income changes there is a movement along a stationary Consumption Curve
  • Slide 27
  • National Income Consumption A B 0
  • Slide 28
  • What can cause a shift in the Consumption Function? Real assets & money holdings Expectations of price changes Interest rates Taxation A change in...
  • Slide 29
  • 29 What is Saving? That part of national income not spent on consumption If, Y = C + S then, S = Y C
  • Slide 30
  • 30 What is the Marginal Propensity to Save (MPS)? The Ratio of the change in saving to the change in income, which induced it.
  • Slide 31
  • Lets assume that your income increases by $100. We observe that you increase your consumption by $80. What is your MPC?
  • Slide 32
  • MPC + MPS = 1 MPC = 1 MPS MPS = 1 MPC
  • Slide 33
  • At each Y level, calculate the MPC, MPS and the S MPC + MPS = 1. 80. 20 40. 80. 20 20. 80. 20 0. 80. 2020. 80. 20100 Y = C + S 60
  • Slide 34
  • C Y Y S 0 0 y*y* y*y* 45 o $ $

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