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1、Topic Three CONSUMPTION AND INVESTMENT,This topic begins the thorough study of the determination of aggregate demand by focusing on the behavior of consumption and investment.Figure 25-1 shows how this analysis fits into the overall structure of the macroeconomy.,CHAPTER 25CONSUMPTION AND INVESTMENT
2、,Figure 25-1.What are the major forces affecting consumption and investment?This chapter analyzes two major components of GNP:consumption and investment.In later chapters,we will see that they affect both aggregate supply and aggregate demand.,A.Consumption and Saving,We begin our discussion with an
3、 analysis of consumption and savings behavior,first examining individual spending patterns and then looking at aggregate consumption behavior.Recall from Chapter 24 that household consumption is spending on final goods and services bought for the satisfaction gained or needs met by their use.Househo
4、ld saving,one the other hand,is by definition that part of income not spent on consumption.Consumption is the largest single component of GDP,constructing 66 percent of total spending over the last decade.Among the most important categories are housing,motor vehicles,food,and medical care.Table 25-1
5、 displays the major elements,broken down into the three categories of durable goods,nondurable goods,and services.,Table 25-1.The major components of consumptionConsumption is divided into three categories:durable goods,nondurable goods and services.The size of the service sector is becoming increas
6、ingly large as basic needs of food are met and as health,recreation and education claim a larger part of family budgets.,Consumption,Income,and SavingWe suggested above that there is a close tie between income,consumption,and saving.Saving is that part of income that is not consumed.That is,saving e
7、quals income minus consumption.Personal saving rate is equal to personal saving as a percent of disposable income.Economic studies have shown that income is the primary determinant of consumption and saving.Rich people save more than poor people,both absolutely and also as a percent of income.The po
8、or people are unable to save at all.Instead,as long as they can borrow or draw down their wealth,they tend to dissave.That is,they tend to spend more than they earn,reducing their accumulated saving or going deeper into debt.Table 25-3 contains illustrative data on disposable income,saving,and consu
9、mption drawn from budget studies on American households.,Table 25-3.Consumption and saving are primarily determined by incomeThis table shows average levels of consumption and saving at different levels of disposable income.The break-even point at which people cease to dissave and begin to do positi
10、ve saving is shown here at$25,000.How much of each extra dollar do people devote to extra consumption at this income level?How much to extra saving?(Answer:about 85 cents and 15 cents,respectively,when we compare row B and row C.),The break-even point where the representative household neither saves
11、 nor dissaves but consumes all its incomecomes at around$25000.Below the break-even point,say at$24000,the household actually consumes more than its income;it disaves.Above break-even point,it begins to show positive saving.To understand the way consumption affects national output,we need to introdu
12、ce some new tools.We need to understand how many extra dollars of consumption and saving are induced by each extra dollar of income.This relationship is shown by:The consumption function,relating consumption and income;and its twin,The savings function,relating saving and income,The Consumption Func
13、tionOne of the most important relationship in all macroeconomics is the consumption function.The consumption function shows the relationship between the level of consumption expenditures and the level of disposable personal income.This concept,introduced by Keynes,is based on the hypothesis that the
14、re is a stable empirical relationship between consumption and income.The relation between consumption and income shown in Figure 25-3 is called the consumption function.At any point on the 450 line,consumption exactly equals income and the household has zero saving.When the consumption function lies
15、 above 450 line,the household is dissaving.When the consumption function lies below 450 line,the household has positive saving.The amount of dissaving or saving is always measured by the vertical distance between the consumption function and the 450 line.,Figure 25-3.A plot of the consumption functi
16、onThe curve through A,B,C,G is the consumption function.The horizontal axis depicts the level of disposal income(DI).For each level of DI,the consumption function shows the dollar level of consumption(C)for the household.Note that consumption rises with increases in DI.The 45line helps locate the br
17、eak-even point and helps our eye measure net saving.,20,000 22,000 24,000 26,000 28,000 30,000Disposable income(dollars),28,00026,000,24,00022,000,20,000,E,DI,C,Consumption expenditures(dollars),45,Break-even point,Savings,E,A,B,C,D,E,F,G,Consumption function,The Saving FunctionThe saving function s
18、hows the relationship between the level of saving and income.This shown graphically in Figure 25-4.Again,we show disposable income on the horizontal axis;but now saving,whether negative or positive in amount,is on the vertical axis.This savings function comes directly from Figure 25-3.It is the vert
19、ical distance between the 450 line and the consumption function For example,at point A in Figure 25-3,we see that the households saving is negative because the consumption function lies above the 450 line.Figure 25-4 shows this dissaving directlythe saving function is below the zero-savings line at
20、point A.Similarly,positive saving occurs to the right of point B because the savings function is above the zero-savings line.,Figure 25-4.The saving function is the mirror image of the consumption functionThis savings schedule is derived by subtracting consumption from income.Graphically,the savings
21、 function is obtained by subtracting vertically the consumption function from the 45line in Fig.25-3.Note that the break-even point B is at the same$25,000 income level as in Fig.25-3.,3,0002,0001,0000-1,000,Net saving(dollars),20,000 22,000 23,000 24,000 25,000 26,000 28,000 30,000Disposable income
22、(dollars),C,DI,A,B,C,D,E,F,G,Saving,The Marginal Propensity to ConsumeThe marginal propensity to consume(MPC)is the extra amount that people consumes when they receive an extra dollar of income.The word“marginal”is used throughout economics to mean extra or additional.For example,“marginal cost”mean
23、s the additional cost of producing an extra unit of output.“Propensity to consume”designates the desired level of consumption that results from an extra dollar of income.Table 25-4 rearranges Table 25-3s data in a more convenient form.First,verify its similarity to Table 25-3.Then,look at columns(1)
24、and(2)to see how consumption expenditure goes up with higher level of income.Column(3)shows how we compute the marginal propensity to consume.,Table 25-4.The marginal propensities to consume and to saveEach dollar of income not consumed is saved.Each dollar of extra income goes either into extra con
25、sumption or into extra saving.Combining these facts allows us to calculate the marginal propensity to consume(MPC)and the marginal propensity to save(MPS).,Marginal Propensity to Consume as Geometrical SlopeWe now know how to calculate the MPC from data on income and consumption.We also want to unde
26、rstand how to calculate MPC graphically;we will see that the MPC is given by the slope of the consumption function.Figuren25-5 shows how to calculate the MPC graphically.Near point B and C a little fight triangle is drawn.As income increases by$1000 from point B to Point C,the amount of consumption
27、rises by$850.The MPC in this range is therefore$850/$1000=0.85.The slope of the consumption function,which measures the change in consumption per dollar change in income,is the marginal propensity to consume.,Figure 25-5.The slope of the consumption function is its MPCTo calculate the marginal prope
28、nsity to consume(MPC),we measure the slope of the consumption function by forming a right triangle and relating height to base.From point B to point C,the increase in consumption is$850 while the change in disposable income is$1000.The slope,equal to the change in C divided by the change in DI,gives
29、 the MPC.If the consumption function is everywhere upward-sloping,what does this imply about the MPC?,20,000 22,000 24,000 26,000 28,000 30,000Disposable income(dollars),28,00026,000,24,00022,000,20,000,DI,C,Consumption expenditures(dollars),A,B,C,D,E,F,G,30,000,$850,$1,000,The Marginal Propensity t
30、o SaveAlong with the marginal propensity to consume goes its mirror image,the marginal propensity to save,or MPS.The marginal propensity to save is defined as the function of an extra dollar of income goes to extra saving.Why are MPC and MPS related like mirror images?Recall that incomes equals cons
31、umption plus saving.This implies that each extra dollar of income must be divided between extra consumption and extra saving.Thus if MPC is 0.85 then MPS must be 0.15.Comparing columns(3)and(5)of Table 25-4 confirms that at any income level,MPC and MPS must always add up to exactly 1,no more and no
32、less.Everywhere and always,MPS=1 MPC.,Brief Review of DefinitionLets review briefly the main definitions we have learned:1.The consumption function relates the level of consumption to the level of disposable income.2.The saving function relates saving to disposable income.Because what is saved equal
33、s what is not consumed,savings and consumption schedules are mirror images.3.The marginal propensity to consume(MPC)is the amount of extra consumption generated by an extra dollar of income.Graphically,it is given by the slope of the consumption function.4.The marginal propensity to save(MPS)is the
34、extra saving generated by an extra dollar of income.Graphically,this is the slope of the saving schedule.5.Because the part of each dollar of income that is not consumed is necessary saved,MPS=1-MPC.,Determinants of Consumption1.Current Disposable Income Informal observation and statistical studies
35、show that the current level of disposable income is the central factor determining a nations consumption.2.Permanent Income The simplest theory of consumption uses only the current income to predict consumption expenditures.Careful studies have shown that people base their consumption expenditures o
36、n long-run income trends as well as on current disposable income.What are some examples?If bad weather destroys a crop,farmers will draw on their previous saving.Because medical students can look forward to high professional earnings,they will borrow for consumption purposes while young.In these cir
37、cumstances,consumers take the long view,asking“Is this years income temporarily high or low?Given my current and future income,how much can I consume today without incurring excessive debts?”,Evidence indicates that consumers generally choose their consumption levels with an eye to both current inco
38、me and long-run income prospects.In order to understand how consumption depends on long-term income trends,economists have developed the permanent-income theory and lifecycle hypothesis.According to the permanent-income theory,consumption responds primarily to permanent income.This approach implies
39、that consumers do not respond equally to all income shocks.If a change in income appears permanent,then people are likely to consume a large fraction of the increase in income.On the other hand,if the income change is clearly transitory,then a significant fraction of the income change may be saved.W
40、ealth and Other Influences A further important determinant of the amount of consumption is wealth.The fact that higher wealth leads to higher consumption is called the wealth effect.Normally,wealth does not change rapidly from year to year.Therefore,the wealth effect seldom causes sharp,movements in
41、 consumption.When the stock market tumbled after 1929,fortunes collapsed and paper-rich capitalists became paupers over-night.Many wealthy people were forced to curtail their consumption.Similarly,as stock prices soared in the mid-1980s,adding more than a trillion dollars to peoples wealth,consumpti
42、on was probably bolstered by the flush of wealth people felt.Other factors are identified from time to time as important determinants of saving or consumption.Some economists believe that saving has been depressed by low rate of return to saving,and argued that a generous social security system redu
43、ces personal saving because we expect to get a large government pension when we retire,we save less for retirement today.Few doubt the importance of permanent income,wealth,social security,and expectations in affecting savings level.But from year to year,the major determinant of changes in consumpti
44、on is actual disposable income.,The Declining US Saving Rate Over the long run,a nations capital formation is determined by its national savings rate.When a nation saves a great deal,its capital stock brows rapidly and it enjoys rapid growth in its potential output.When a nations savings rate is low
45、,its equipment and factories become obsolete and its infrastructure begins to rot away.This close relationship between saving,investment,and economic growth is the major reason why economists worry about a nations saving rate.What are the major reasons affecting the US savings rate?Federal budget de
46、ficit.Most economists believe that high budget deficits stimulate consumption and thereby lower national saving.Social security system.Many economists have argued that the introduction of the social security system has removed some of the need for private saving.,Capital markets.Until recently,capit
47、al markets had numerous imperfections.People found it hard to borrow funds for worthwhile purposes,whether for buying a house,financing an education,or starting a business.As capital markets developed,often with the help government,new loan instruments allowed people to borrow more easily.Other sour
48、ces.Many other culprits have been indicated in the case of the declining national saving rate.Some analysts pointed to high inflation in the late 1980s.Others pointed to diluted incentives to save in recent years to saving because of high tax rates and low post-tax returns to saving.The declining na
49、tional savings rate remains a puzzling phenomenon testing the ingenuity of macroeconomics.While no one has demonstrated conclusively why the US national savings rate has dropped so sharply in recent years,virtually all believe that the savings rate is too low to guarantee a vital and healthy rate of
50、 investment in the 1990s.,B.The Determinants of Investment,The second major component of private spending is investment.Investment plays two roles in macroeconomics.First,because it is a large and volatile component of spending,sharp changes in investment can have a major impact on aggregate demand.
