Basic Relationships Income and Consumption and Saving Schedules

Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Key Terms End Show 8 -1 8 Basic Macroeconomic Relationships Copyright 2008 The Mc. Graw-Hill Companies

Chapter Objectives Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Key Terms End Show 8 -2 • How Changes in Income Affect Consumption (and Saving) • About Factors Other Than Income That Can Affect Consumption • How Changes in Real Interest Rates Affect Investment • About Factors Other Than the Real Interest Rate That Can Affect Investment • Why Changes in Investment Increase or Decrease Real GDP by a Multiple Amount Copyright 2008 The Mc. Graw-Hill Companies

Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word • Income-Consumption • Income-Saving • 45° Line • C = DI on the Line • S = DI - C Key Terms End Show 8 -3 Copyright 2008 The Mc. Graw-Hill Companies

Income and Consumption and Disposable Income, 1983 -2005 05 45° Reference Line C=DI Consumption (billions of dollars) Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word 04 03 00 01 02 99 Saving In 1992 83 84 91 90 89 88 87 86 85 97 98 96 95 94 93 92 Consumption In 1992 45° Key Terms End Show Disposable Income (billions of dollars) 8 -4 Copyright 2008 The Mc. Graw-Hill Companies C

Consumption and Saving Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word • The Consumption Schedule • The Saving Schedule • Break-Even Income • Average Propensity to Consume (APC) • Average Propensity to Save (APS) Consumption APC = Income Key Terms End Show 8 -5 Copyright 2008 The Mc. Graw-Hill Companies APS = Saving Income O 8. 1

Consumption and Saving Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word • Marginal Propensity to Consume (MPC) • Marginal Propensity to Save (MPS) Change in Consumption MPC = Change in Income Change in Saving MPS = Change in Income Key Terms End Show 8 -6 Copyright 2008 The Mc. Graw-Hill Companies

Consumption and Saving Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Key Terms (1) Level of (2) Output Consump. And tion Income (C) (GDP=DI) (1) $370 (4) (5) (6) (7) Average Marginal Propensity (3) to Consume to Save Saving (S) (APC) (APS) (MPC) (MPS) (1 -2) (2)/(1) (3)/(1) Δ(2)/Δ(1) Δ(3)/Δ(1) $375 $-5 1. 01 -. 01 (2) 390 0 1. 00 (3) 410 405 5 . 99 . 01 (4) 430 420 10 . 98 . 02 (5) 450 435 15 . 97 . 03 (6) 470 450 20 . 96 . 04 (7) 490 465 25 . 95 . 05 (8) 510 480 30 . 94 . 06 (9) 530 495 35 . 93 . 07 (10) 550 510 40 . 93 . 07 End Show 8 -7 Copyright 2008 The Mc. Graw-Hill Companies . 75 . 25

Consumption and Saving Key Terms End Show 8 -8 500 C 475 450 425 Saving $5 Billion Consumption Schedule 400 375 Dissaving $5 Billion 45° Saving (billions of dollars) Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Consumption (billions of dollars) Consumption and Saving Schedules 370 390 410 430 450 470 490 510 530 550 Disposable Income (billions of dollars) 50 Dissaving 25 $5 Billion 0 Saving Schedule S Saving $5 Billion 370 390 410 430 450 470 490 510 530 550 Copyright 2008 The Mc. Graw-Hill Companies

Consumption and Saving GLOBAL PERSPECTIVE Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Average Propensities to Consume Select Nations GDPs Average Propensities to Consume. 80 . 95 1. 00 . 963. 958 Canada . 953 United Kingdom . 942 Japan Germany . 896 Netherlands . 893 France End Show . 90 United States Italy Key Terms . 85 . 840. 833 Source: Statistical Abstract of the United States, 2006 8 -9 Copyright 2008 The Mc. Graw-Hill Companies

Consumption and Saving Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Key Terms End Show 8 -10 • MPC + MPS = 1 • MPC and MPS as Slopes • Nonincome Determinants of Consumption and Saving – Wealth Effect – Expectations – Real Interest Rates – Household Debt Copyright 2008 The Mc. Graw-Hill Companies W 8. 1

Consumption and Saving Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Key Terms End Show 8 -11 • Other Important Considerations • Changes Along Schedules • Switch to Real GDP • Schedule Shifts • Stability • Taxation Copyright 2008 The Mc. Graw-Hill Companies G 8. 1

Consumption and Saving Schedules Key Terms End Show 8 -12 Consumption (billions of dollars) C 0 C 2 45° Saving (billions of dollars) Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word C 1 Disposable Income (billions of dollars) Copyright 2008 The Mc. Graw-Hill Companies S 2 S 0 S 1

Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Interest Rate and Investment • Expected Rate of Return (r) • The Real Interest Rate (i) • Meaning of r = i • Investment Demand Curve O 8. 2 G 8. 2 Key Terms End Show 8 -13 Copyright 2008 The Mc. Graw-Hill Companies

Interest Rate and Investment Cumulative Amount of Investment Having This Rate of Expected Return or Higher Rate of (i) Return (r) 16% 14% 12% 10% 8% 6% 4% 2% 0% $ 0 5 10 15 20 25 30 35 40 Key Terms 16 14 r and i (percent) Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word The Investment Demand Curve 12 10 8 6 4 ID 2 0 5 10 15 20 25 30 35 Investment (billions of dollars) End Show 8 -14 Copyright 2008 The Mc. Graw-Hill Companies 40

Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Key Terms End Show 8 -15 Interest Rate and Investment • Shifts of the Investment Demand Curve – Acquisition, Maintenance, and Operating Costs – Business Taxes – Technological Change – Stock of Capital Goods on Hand – Expectations Copyright 2008 The Mc. Graw-Hill Companies

Interest Rate and Investment Key Terms Increase in Investment Demand r and i (percent) Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Shifts in the Investment Demand Curve Decrease in Investment Demand 0 Investment (billions of dollars) End Show 8 -16 Copyright 2008 The Mc. Graw-Hill Companies ID 2 ID 0 ID 1

Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Interest Rate and Investment • Instability of Investment – Durability – Irregularity of Innovation – Variability of Profits – Variability of Expectations Key Terms End Show 8 -17 Copyright 2008 The Mc. Graw-Hill Companies

Interest Rate and Investment GLOBAL PERSPECTIVE Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Gross Investment Expenditures as a Percent of GDP, Select Nations Percent of GDP, 2004 0 10 20 30 South Korea Japan Mexico Canada France United States Germany Key Terms United Kingdom End Show Sweden Source: World Bank 8 -18 Copyright 2008 The Mc. Graw-Hill Companies

Interest Rate and Investment The Volatility of Investment Percentage Change Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Gross Investment GDP 1971 1975 Key Terms 1979 1983 1987 1991 Year End Show 8 -19 Copyright 2008 The Mc. Graw-Hill Companies 1995 1999 2003

The Multiplier Effect Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Multiplier = Change in Real GDP Initial Change in Spending The Multiplier and the Marginal Propensities Multiplier = -or. Multiplier = Key Terms 1 1 - MPC 1 MPS Graphically… End Show 8 -20 W 8. 2 Copyright 2008 The Mc. Graw-Hill Companies

The Multiplier Effect Tabular and Graphical Views Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Increase in Investment of $5 Second Round Third Round Fourth Round Fifth Round All other rounds Total 8 -21 $ 15. 00 $4. 75 15. 25 13. 67 11. 56 8. 75 $1. 58 $2. 11 $2. 81 ΔI= $5 billion $3. 75 $5. 00 1 End Show $ 20. 00 $20. 00 5. 00 Key Terms (2) (3) Change in (1) Saving Change in Consumption (MPC =. 75) (MPC =. 25) Income $ 5. 00 $ 3. 75 $ 1. 25 3. 75 2. 81. 94 2. 81 2. 11. 70 2. 11 1. 58. 53 1. 58 1. 19. 39 4. 75 3. 56 1. 19 Copyright 2008 The Mc. Graw-Hill Companies 2 3 4 Rounds of Spending 5 All

The Multiplier Effect The MPC and the Multiplier Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Key Terms MPC Multiplier . 9 10 . 8 5 . 75 4 . 67. 5 3 2 End Show 8 -22 Copyright 2008 The Mc. Graw-Hill Companies

Squaring the Economic Circle Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Key Terms End Show 8 -23 t s a L d r Wo • Humorist Art Buchwald and the Multiplier • One Person Can’t Buy a Product • Others Subsequently Impacted and Cannot Buy Other Items • Multiple Effects Impact Psyche • Ultimately Causes Multiple Step Impact Upon the Economy as a Whole Copyright 2008 The Mc. Graw-Hill Companies

Key Terms Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word Key Terms End Show 8 -24 • 45° (degree) line • consumption schedule • saving schedule • break-even income • average propensity to consume (APC) • average propensity to save (APS) Copyright 2008 The Mc. Graw-Hill Companies • marginal propensity to consume (MPC) • marginal propensity to save (MPS) • wealth effect • expected rate of return • investment demand curve • multiplier

Next Chapter Preview… Basic Relationships Income and Consumption and Saving Schedules Changes in C & S Interest Rate and Investment Demand Curve Shifts in the Investment Demand Curve Volatility of Investment Multiplier Effect Last Word The Aggregate Expenditures Model Key Terms End Show 8 -25 Copyright 2008 The Mc. Graw-Hill Companies