Expenditure

Chapter 12

Four Components of Expenditure

• Personal Consumption Expenditure

• Government Consumption Expenditure

• Investment

• Net Exports

Consumption, Investment, and Net Exports are determined in the private sector.

Categories ofSpending

2005 Gross domestic product....... 12455.8 Personal consumption expenditures. 8742.4 Durable goods................... 1033.1 Motor vehicles and parts...... 448.2 Furniture and household equipment.................... 377.2 Other......................... 207.7 Nondurable goods................ 2539.3 Food.......................... 1201.4 Clothing and shoes............ 341.8 Gasoline, fuel oil, and other energy goods................. 302.1 Other......................... 694.0 Services........................ 5170.0 Housing....................... 1304.1 Household operation........... 483.0 Electricity and gas......... 199.8 Other household operation... 283.2 Transportation................ 320.4 Medical care.................. 1493.4 Recreation.................... 360.6 Other......................... 1208.4

BEA NIPA Table 2.3.5

Consumption in HK• Four consumption

categories1. Food

2. Non-Durables: Clothes, Toys

3. Durables: White Goods, Electronics

4. Services: Health, Rental

0

20

40

60

80

100

120

140

1970 1975 1980 1985 1990 1995 2000

FOODDURABLES

NONDURABLESSERVICES

Consumption Shares in HK

Source: CEIC Database

HK Personal Consumption Expenditure

Million HK$ 2007Private Consumption Expenditure 986,821Food & Non-alcoholic Beverages 115,673 11.7%Alcoholic Beverages 4,612 0.5%Tobacco 4,210 0.4%Clothing, Footwear & Other Personal Effects 115,798 11.7%Rent, Rates, Water & Housing Maintenance 151,150 15.3%Fuel & Light 15,953 1.6%Furniture, Furnishings & Household Equipment 67,559 6.8%Household Operation 19,264 2.0%Personal Care 23,491 2.4%Medical Care & Health Expenses 40,566 4.1%Transport & Communications 83,309 8.4%Recreation & Entertainment 61,560 6.2%Education 19,599 2.0%Other Services 263,605 26.7%

HK Short-term: Year to year growth

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

0.419

67

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

Durables

NonDurables

GDP

Theory of consumption best explains non-durables, services and food consumption. HK NIPA Table 038

Gross Domestic Investment (and Components)

Table 5.2.5. Gross and Net Domestic Investment by Major Type [Billions of dollars] Bureau of Economic AnalysisDownloaded on 10/23/2006 At 8:46:47 AM Last Revised August 02, 2006 Line

Gross Depreciation Net % of GDI1 Gross domestic investment 2454.5 1604.8 849.7 100.00%4 Gross private domestic investment 2057.4 1352.6 704.8 83.82%

22 Change in private inventories7 Fixed investment 2036.2 1352.6 683.6 82.96%

10 Nonresidential 1265.7 1045.6 220.1 51.57%13 Structures 338.6 260.6 78 13.80%16 Equipment and software 927.1 785 142.1 37.77%19 Residential 770.4 307 463.4 31.39%23 Gross government investment\1\ 397.1 252.2 144.8 16.18%30 Structures 248.9 127.4 121.5 10.14%37 Equipment and software 148.1 124.8 23.3 6.03%

BEA NIPA Table 5.2.5

Investment HK, 2007

Million HK$ 2007Gross Fixed Capital Formation (GFCF) 325,349Building and Construction 111,777 34.4% Private 86,983 26.7% Public 24,794 7.6%Costs of Ownership Transfer 24,497 7.5%Machinery, Equipment and Computer Software 189,075 58.1% Private 182,113 56.0% Public 6,962 2.1%

Volatility: Investment and GDPAnnual Growth Rates

Hong Kong

-20.00%

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

% G

row

th R

ate

s

GDP

I

Government Consumption Expenditure: Hong Kong

Milion HK$ 2007Expenditure 130,398Compensation of Employees 100,674 77.2%Purchases of Goods & Services 41,013 31.5%Sales by Non Trading Govt Dept 11,289 8.7%

Consumption and Disposable Income

• Many households live paycheck to paycheck and will spend money as it comes in. Thus, consumption is a function of disposable income which increases with income.

} }argm inal

Increase in Increase inpropensityConsumption Incometo consume

C mpc Y

Factors Affecting the Level of Autonomous Consumption

Spending• Personal taxes

• Real interest rate

• Consumer confidence

• Existing stock of wealth– Strongly affected by stock and RE prices

• Availability of consumer credit

• Stock of consumer debt outstanding

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13

Investment and Cash Flow

• Financial Accelerator Effect: Download When business cycle conditions improve, business cash flow also improves. Businesses, especially those without access to financial markets, rely on cash flow for financing.

} }argm inal

Increase in Increase inpropensityConsumption Incometo invest

I mpinv Y

Determinants of Gross Private Domestic Investment

• Level of real income and output in the economy

• Real interest rates

• Business taxes

• Expected Profits and Business Confidence

• Capacity utilization rates

• Residential Investment Spending

• Inventory Investment

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15

Multiplier Effect in the Open Economy

• Multiplier feedback is moderated by international trade.

• Some of the extra expenditure generated by extra income/cash flow will be spent on imports and thus not generate extra demand for domestic goods.

• Multiplier effect smaller in economies that spend a high fraction of their income on imported goods.

Expenditure Function

E0

Autonom

ous

Expenditure

mpex mpc mpinv mpim

1

E

Y

Expenditure is a Feedback Loop

• Expenditure is determined by household and corporate income.

• Income is determined by the value added of output in the economy.

• Output will be determined by demand for expenditure.

Y=E

Equilibrium Expenditure

E0

mpex

E

Y

Y=E

YD

0

0

0

(1 )

1

D D

D

D

Y E E mpex Y

mpex Y E

EY

mpex

Disequilibrium Level Income and Output Adjustment

Relationship of E to Y Inventories Output Adjustment

E > YUnexpected decrease in inventories

Output increases

E = Y Inventories are at expected level

Output equilibrium

E < YUnexpected increase in inventories

Output decreases

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20

Multiplier Effect

• Changes in autonomous expenditure will have multiple impacts on output.

• The higher is the marginal propensity to consume or invest, the larger is that multiple.

• The more open is the economy, the smaller is that multiple.

Multiplier Effect (if mpinv,mpim=0)

IncomeIncome

ProductionProduction

SavingsSavings

ConsumptionConsumption

Multiplier Effect 2

IncomeIncome

ProductionProduction

SavingsSavings

ConsumptionConsumption

Multiplier Effect 3

IncomeIncome

ProductionProduction

SavingsSavings

ConsumptionConsumption

Multiplier Effect: Open Economy

IncomeIncome

ProductionProduction

SavingsSavings

ConsumptionConsumption

ImportsImports

Interest and Autonomous Expenditure

• There is negative relationship between the real interest rate and consumption and expenditure.

• Real interest rate, r, is:– the direct cost of financing corporate

investment, housing, or consumer durables.– the return on saving and thus the opportunity

cost of consumption.

Interest Sensitive Autonomous Expenditure

• Define as the part of expenditure which is interest sensitiv and NIRE as the non-interest sensitive component.

• Autonomous expenditure is a negatively related to the real interest rate. This means that equilibrium expenditure is negatively related to expenditure

( )IRE r

0 ( ) ( )E r IRE r NIRE

Consider r2 < r1

E0(r1

)

E

Y

Y=E

YD(r1

)

0

0

0

(1 )

1

D D

D

D

Y E E mpex Y

mpex Y E

EY

mpex

E0(r2

)

Learning Outcomes

• Students should be able to name the main components of expenditure and their determinants.

• Students should be able to calculate equilibrium expenditure as a multiple of autonomous expenditure.

• Use the model of equilibrium expenditure to explain the effect of events on demand for goods.