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Chapter 28
Basic Macroeconomic Relationships
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
28-2
LO1. Describe how changes in income affect consumption (and saving).LO2. List & explain factors other than income that can affect consumptionLO3. Explain how changes in real interest rate affect investmentLO4. Identify & explain factors other than RIR that can affect investmentLO5. Illustrate how changes in investment (or one of the other components of total spending) can increase or decrease real GDP by a multiple amount.
28-3
LO1. Describe how changes in income affect consumption (and saving).
28-4
• Consumption and saving• Primarily determined by DI (disposable income = Income – Tax)• Direct relationship• DI – Consumption = Saving
• Consumption schedule• Planned household spending (in our model)
• Saving schedule• DI minus C• Dissaving can occur, dissaving (terlebih belanja) using borrowing or by selling asset.
Income Consumption and Saving
LO1
28-5
Income Consumption and Saving
LO1
28-6
Consumption and Saving Schedules
Consumption and Saving Schedules (in Billions) and Propensities to Consume and Save
(1)Level of
Output and IncomeGDP=DI
(2)Consumption
(C)
(3)Saving (S),
(1) – (2)
(4)Average
Propensity to Consume
(APC),(2)/(1)
(5)Average
Propensity to Save (APS),
(3)/(1)
(6)Marginal
Propensity to Consume(MPC),
(2)/(1)*
(7)Marginal
Propensity to Save
(MPS),(3)/(1)*
(1) $370 $375 $-5 1.01 -.01 .75 .25
(2) 390 390 0 1.00 .00 .75 .25
(3) 410 405 5 .99 .01 .75 .25
(4) 430 420 10 .98 .02 .75 .25
(5) 450 435 15 .97 .03 .75 .25
(6) 470 450 20 .96 .04 .75 .25
(7) 490 465 25 .95 .05 .75 .25
(8) 510 480 30 .94 .06 .75 .25
(9) 530 495 35 .93 .07 .75 .25
(10) 550 510 40 .93 .07 .75 .25
LO1
28-7
Consumption and Saving Schedules
370 390 410 430 450 470 490 510 530 550
C
S
Consumptionschedule
Saving schedule
Saving $5 billion
Dissaving $5 billion
Dissaving$5 billion Saving $5 billion
Con
sum
ptio
n (b
illio
ns o
f dol
lars
)Sa
ving
(bill
ions
of d
olla
rs)
Disposable income (billions of dollars)LO1
28-8
Average Propensities(Purata kecenderungan)
• Average propensity to consume (APC)• Fraction of total income consumed
• Average propensity to save (APS)• Fraction of total income saved
APC = APS =consumption
income incomesaving
APC + APS = 1LO1
28-9
Global Perspective
LO1
28-10
Marginal Propensities(Kadar perubahan kecenderungan untuk
berbelanja/menyimpan)
• Marginal propensity to consume (MPC)• Proportion of a change in income consumed
• Marginal propensity to save (MPS)• Proportion of a change in income saved
MPC = MPS =change in consumption
change in income change in income
change in saving
MPC + MPS = 1LO1
28-11
Marginal Propensities
Disposable income
Con
sum
ptio
nSa
ving
S
CMPC =
MPS =
1520 = .75
C ($15)
DI ($20)
DI ($20)
S ($5)
520 = .25
LO1LO1
28-12
Nonincome Determinants
• Amount of disposable income is the main determinant
• Other determinants of consumption & savings• Wealth• Borrowing• Expectations• Real interest rates
LO2
28-13
Other Important Considerations
• Switching to real GDP• Changes along schedules• Simultaneous shifts• Taxation• Stability
LO2
28-14
Shifts of C & S Schedules
C0
S0
Real GDP (billions of dollars)
Con
sum
ptio
n(b
illio
ns o
f dol
lars
)Sa
ving
(bill
ions
of d
olla
rs)
C2
C1
S1
S2
0
0
-
+
LO2LO2
28-15
LO3. Explain how changes in real interest rate affect investmentLO4. Identify & explain factors other than RIR that can affect investment
28-16
• Investment consists of spending on new plants, capital equipment, machinery, inventories, construction, etc.
• The investment decision weighs marginal benefits and marginal costs.
• The expected rate of return is the marginal benefit.
• The interest rate (the cost of borrowing funds) represents the marginal cost.
Interest-Rate-Investment Relationship
LO3
28-17
Investment Demand Curve
ID
(r) and (i)
Investment(billions
of dollars) 16% $ 0
14 5
12 10
10 15
8 20
6 25
4 30
2 35
0 40
Investmentdemandcurve
LO3 Interest rate = financial price
28-18
Shifts of Investment Demand occurs when any investment determinants change.
LO4
28-19
Shifts of Investment Demand E
xpec
ted
rate
of r
etur
n, r,
and
real
inte
rest
rate
, i (p
erce
nts)
0 Investment (billions of dollars)
ID0ID1ID2
Increasein investmentdemand
Decrease in investmentdemand
LO4
28-20
Global Perspective
LO4
28-21
Instability of Investment
• Investment is a very unstable type of spending. • Ig is more volatile than GDP• REASONS
• Variability of expectations• Durability• Irregularity of innovation• Variability of profits
LO4
28-22
Instability of Investment
LO4
28-23
The Multiplier Effect
• Def: A change in spending changes real GDP more than the initial change in spending
• Layman: increase in final income arising from any new injection of spending.
Multiplier =change in real GDP
initial change in spending
Change in GDP = multiplier x initial change in spending
LO5
28-24
28-25
28-26
The Multiplier Effect
(1)Change in
Income
(2)Change in
Consumption (MPC = .75)
(3)Change in
Saving(MPS = .25)
Increase in investment of $5.00 $5.00 $3.75 $1.25
Second round 3.75 2.81 .94
Third round 2.81 2.11 .70
Fourth round 2.11 1.58 .53
Fifth round 1.58 1.19 .39
All other rounds 4.75 3.56 1.19
Total $20.00 $15.00 $5.00
$5.00
$3.75
$2.81$2.11
$1.58$4.75
Cum
ulat
ive
inco
me,
GD
P (b
illio
ns
of d
olla
rs)
20.00
15.2513.67
11.56
8.75
5.00 2 3 54 All others1LO5
28-27
Multiplier and Marginal Propensities
• Multiplier and MPC directly related• Large MPC results in larger increases in spending
• Multiplier and MPS inversely related• Large MPS results in smaller increases in spending
Multiplier =1
1- MPCMultiplier =
1MPS
LO5
28-28
Multiplier and Marginal Propensities
10
5
4
3
2.5
.67
.75
.8
.9
MPC Multiplier
LO5
28-29
The Actual Multiplier Effect?
• Actual multiplier is lower than the model assumes
• Consumers buy imported products• Households pay income taxes• Inflation• Multiplier may be 0
LO5
28-30
Squaring the Economic Circle
• Humorous small town example of the multiplier
• One person in town decides not to buy a product
• Creates a ripple effect of people not spending, following the first decision
• Ultimately the entire town experiences an economic downturn