lec-10b & 11 - ch 12 - consumption, real gdp and multiplier - miller edited.ppt
TRANSCRIPT
Chapter 12
Consumption, Real GDP, and the Multiplier
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Did You Know That ...
• The share of real GDP allocated to real consumption spending is:– 66 percent in Germany– 60 percent in the United Kingdom– 70 percent in the United States– Less than 41 percent in China?
• In this chapter, you will learn how an understanding of households’ real saving and real consumption spending can help you evaluate fluctuations in a national’s real GDP.
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Some Simplifying Assumptions in a Keynesian Model
• To simplify the income determination model, let’s assume:
1. Businesses pay no indirect taxes (sales tax)
2. Businesses distribute all profits to shareholders
3. There is no depreciation
4. The economy is closed; no foreign trade
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Some Simplifying Assumptions in a Keynesian Model (cont'd)
• Real Disposable Income– Real GDP minus net taxes, or after-tax real
income
• Consumption– Spending on new goods and services out of a
household’s current income
– Whatever is not consumed is saved
– Consumption includes such things as buying food and going to a concert
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Some Simplifying Assumptions in a Keynesian Model (cont'd)
• Saving
– The act of not consuming all of one’s current income
– Whatever is not consumed out of spendable income is, by definition, saved
– Saving is an action measured over time (a flow)
– Savings are a stock, an accumulation resulting from the act of saving in the past
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Some Simplifying Assumptions in a Keynesian Model (cont'd)
• Consumption Goods
– Goods bought by households to use up, such as food and movies
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Some Simplifying Assumptions in a Keynesian Model (cont'd)
• Accounting identity:
Consumption + saving disposable income
Saving disposable income – consumption
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Some Simplifying Assumptions in a Keynesian Model (cont'd)
• Investment
– Spending by businesses on things such as machines and buildings, which can be used to produce goods and services in the future
– The investment part of real GDP is the portion that will be used in the process of producing goods in the future
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Some Simplifying Assumptions in a Keynesian Model (cont'd)
• Capital Goods
– Producer durables; nonconsumable goods that firms use to make other goods
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Determinants of Planned Consumption and Planned Saving
• In the classical model, the supply of saving was determined by the rate of interest
– The higher the rate, the more people wanted to save, and the less they wanted to consume
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Determinants of Planned Consumption and Planned Saving (cont'd)
• Keynes argued that: – The interest rate is not the most important factor
in saving and consumption decisions– Rather, real saving and consumption decisions
depend primarily on a household’s real disposable income.
– Furthermore, a person’s anticipation about future flows of income influences how much of current income is allocated to consumption and how much is allocated to saving.
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Determinants of Planned Consumption and Planned Saving (cont'd)
• The Keynesian Theory of Consumption and Saving– Keynes argued that real consumption and saving
decisions depend primarily on a household’s current real disposable income.
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Determinants of Planned Consumption and Planned Saving (cont'd)
• Consumption Function
– The relationship between amount consumed and disposable income
– A consumption function tells us how much people plan to consume at various levels of disposable income
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Determinants of Planned Consumption and Planned Saving (cont'd)
• Dissaving
– Negative saving; a situation in which spending exceeds income
– Dissaving can occur when a household is able to borrow or use up existing assets
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Table 12-1 Real Consumption and Saving Schedules: A Hypothetical Case
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Determinants of Planned Consumption and Planned Saving (cont'd)
• 45-Degree Reference Line
– The line along which planned real expenditures equal real GDP per year
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Figure 12-1 The Consumption and Saving Functions
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Determinants of Planned Consumption and Planned Saving (cont'd)
• Autonomous Consumption
– The part of consumption that is independent of the level of disposable income
– Changes in autonomous consumption shift the consumption function
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Determinants of Planned Consumption and Planned Saving (cont'd)
• Average Propensity to Consume (APC)
– Real consumption divided by real disposable income
– The proportion of total disposable income that is consumed
APC =Real consumption
Real disposable income
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Determinants of Planned Consumption and Planned Saving (cont'd)
• Average Propensity to Save (APS)
– Real saving divided by real disposable income (DI)
– Saved proportion of real DI
APS =Real saving
Real disposable income
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MPC =Change in real consumption
Change in real disposable income
Determinants of Planned Consumption and Planned Saving (cont'd)
• Marginal Propensity to Consume (MPC)
– The ratio of the change in real consumption to the change in real disposable income
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MPS =Change in real saving
Change in real disposable income
Determinants of Planned Consumption and Planned Saving (cont'd)
• Marginal Propensity to Save (MPS)
– The ratio of the change in saving to the change in disposable income
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APC =$49,200
$54,000= .911
Determinants of Planned Consumption and Planned Saving (cont'd)
• Example– Income = $54,000
– C = $49,200
– S = $4,800
• What is the APC?
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APC =$54,000
$60,000= .90
Determinants of Planned Consumption and Planned Saving (cont'd)
• Example– Income increases by $6,000 to $60,000
– C = $54,000
– S = $6,000
• What is the APC?
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Determinants of Planned Consumption and Planned Saving (cont'd)
• Some relationships
APC + APS 1
MPC + MPS 1
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Determinants of Planned Consumption and Planned Saving (cont'd)
• Causes of shifts in the consumption function
– A change besides real disposable income will cause the consumption function to shift
– Non-income determinants of consumption• Population
• Wealth
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Determinants of Investment
• Investment, you will remember, consists of expenditures on new buildings and equipment
– Gross private domestic investment has been volatile
– Consider the planned investment function, and shifts in the function
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Figure 12-2 Planned Real Investment, Panel (a)
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Figure 12-2 Planned Real Investment, Panel (b)
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Determining Equilibrium Real GDP
• We are interested in determining the equilibrium level of real GDP per year
– Consumption as a function of real GDP
– The 45-degree reference line
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Figure 12-3 Consumption as a Function of Real GDP
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Determining Equilibrium Real GDP (cont'd)
• Adding the investment function
AD = C + I + G + X
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Figure 12-4 Combining Consumption and Investment
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Determining Equilibrium Real GDP (cont'd)
• Saving and investment: Planned versus Actual
– Only at equilibrium real GDP will planned saving equal actual saving
– Planned investment equals actual investment
– Hence planned saving is equal to planned investment
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Figure 12-5 Planned and Actual Rates of Saving and Investment
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Determining Equilibrium Real GDP (cont'd)
• Unplanned increases in business inventories
– Consumers purchase fewer goods and services than anticipated
– This leaves firms with unsold products and inventories will rise
– Businesses respond by cutting back production and reducing employment
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Determining Equilibrium Real GDP (cont'd)
• Unplanned decreases in business inventories
– Business will increase production of goods and services and increase employment
– Ultimately there will be an increase in real GDP
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Keynesian Equilibrium with Government and the Foreign Sector Added
• To this point we have ignored the role of government in our model
• We also left out the foreign sector of the economy in our model
• Let’s think about what happens when we add these elements
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Keynesian Equilibrium with Government and the Foreign Sector Added (cont'd)
• Government (G): C + I + G– Federal, state, and local
• Does not include transfer payments• Is autonomous• Lump-sum taxes = G
• Lump-Sum Tax– A tax that does not depend on income or the
circumstances of the taxpayer
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Keynesian Equilibrium with Government and the Foreign Sector Added (cont'd)
• The Foreign Sector: C + I + G + X
– Net exports (X) equals exports minus imports
– Depends on international economic conditions
– Autonomous—independent of real national income
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Table 12-2 The Determination of Equilibrium Real GDP with Government and Net Exports Added
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Keynesian Equilibrium with Government and the Foreign Sector Added (cont'd)
• Determining the equilibrium level of GDP per year
– We are now in a position to determine the equilibrium level of real GDP per year
– Remember that equilibrium always occurs when total planned real expenditures equal real GDP
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Figure 12-6 The Equilibrium Level of Real GDP
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Keynesian Equilibrium with Government and the Foreign Sector Added (cont'd)
The Equilibrium Level of Real GDP• Observations
– If C + I + G + X = Y • Equilibrium GDP
– If C + I + G + X > Y • Unplanned decrease in inventories• Businesses raise output• Y returns to equilibrium
– If C + I + G + X < Y• Unplanned increase in inventories• Businesses reduce output• Y returns to equilibrium
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The Multiplier
• Multiplier
– The ratio of the change in the equilibrium level of real national income to the change in autonomous expenditures
– The number by which a change in autonomous real investment or autonomous real consumption is multiplied to get the change in equilibrium real GDP
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The Multiplier (cont'd)
• Question– How can a $100 billion increase in investment
generate a $500 billion increase in equilibrium real GDP?
• Answer– The multiplier process
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Table 12-3 The Multiplier Process
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The Multiplier (cont'd)
• The multiplier formula
Multiplier = 11 - MPC
= 1MPS
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The Multiplier (cont'd)
• By taking a few numerical examples, you can demonstrate to yourself an important property of the multiplier
– The smaller the MPS, the larger the multiplier
– The larger the MPC, the larger the multiplier
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The Multiplier (cont'd)
• Examples
MPC =45
MPS =15
Multiplier =1
1/5= 5
MPC =35
MPS =25
Multiplier =1
2/5= 2.5
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Change in equilibrium real GDP = Multiplier x Change in autonomous spending
The Multiplier (cont'd)
• Measuring the change in equilibrium income from a change in autonomous spending
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The Multiplier (cont'd)
• Significance of the multiplier
– It is possible that a relatively small change in consumption or investment can trigger a much larger change in real GDP
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Figure 12-7 Effect of a Rise in Autonomous Spending on Equilibrium Real GDP
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Figure C-1 Graphing the Multiplier