Chapter

Chapter 21
21
Consumption &
Investment

01/20/25
©1999 South-Western College Publishing
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 What
What is
is the
the
Consumption
Consumption Function?
Function?
The relationship between
consumption and income
C = F(Y)
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Real Consumption The Consumption Function

C
C

Y
Real Disposable Income
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 What
What is
is Saving?
Saving?
That part of national
income not spent on
consumption

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Consumption, Saving Consumption Function

a v i n g C
S

45o

Income
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C, S

45o

Y3 Y1 Y2 Y
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On the previous graph,
At Y1, C=Y, so S=0
At Y2, C<Y, positive savings
At Y3, C>Y, negative savings
(dissaving

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What
What is
is the
the Marginal
Marginal
Propensity
Propensity to
to consume
consume
((MPC)?
MPC)?
Change in consumption
brought about by a change
in income (the slope of the
consumption function)

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 What
What is
is the
the Marginal
Marginal
Propensity
Propensity to
to
Save(MPS)?
Save(MPS)?
The change in saving induced
by a change in income

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 MPC
MPC == ΔC/ ΔY
ΔC/ ΔY
MPS
MPS == ΔS/
ΔS/ ΔY
ΔY
Example:
Example: Y Y == 500,
500, C C == 400,
400, SS == 100
100
Y
Y11 == 600,
600, C
C11 == 480,
480, SS11 == 120
120
ΔY=
ΔY= 100,
100, ΔC
ΔC == 80,
80, ΔS=20
ΔS=20
so
so MPC
MPC == 80/100
80/100 == .8
.8
MPS
MPS == 20/100
20/100 == .2
.2

 10
 Note that
MPC + MPS
must equal 1

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 If household's income rises
from $30,000 to $33,000 and
consumption rises from
$28,000 to $30,000, then
MPC = $2000 / $3,000 = .67
MPS = $1000 / $3,000 = .33

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 What
What is
is
Autonomous
Autonomous Consumption?
Consumption?
Consumption spending
that is independent of
the level of income

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 What
What is
is significant
significant about
about
Autonomous
Autonomous Consumption?
Consumption?
Even when income is
zero, autonomous
spending is positive

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Real Consumption The Consumption Function

C
C
a
Y
Real Disposable Income
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 What
What is
is the
the
Consumption
Consumption Equation?
Equation?
C = a + bY
Autonomous Consumption Income
MPC

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 Many
Many theories
theories of
of the
the
consumption
consumption function
function
Note that a straight line C
function assumes a
constant MPC

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 Who
Who was
was
John
John Maynard
Maynard Keynes?
Keynes?
Economist who had a
book published in 1936
named “The General
Theory of Employment,
Interest and Money”
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What
What is
is Keynes’
Keynes’ Absolute
Absolute
Income
Income Hypothesis?
Hypothesis?
As income increases,
consumption spending
increases, but by
diminishing amounts
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According
According to
to the
the absolute
absolute
income
income hypothesis,
hypothesis, What
What
happens
happens to
to the
the MPC
MPC asas
income
income increases?
increases?
MPC decreases as income
increases and increases
as income decreases
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Who
Who was
was Simon
Simon Kuznets?
Kuznets?
An economists who
published a book in 1941
named “National Income
and Its Composition”

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 What
What did
did Kuznets
Kuznets
say
say in
in his
his book?
book?
MPC tends to remain
fairly constant regardless
of the absolute level of
national income
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 What
What isis Duesenberry’s
Duesenberry’s
Relative
Relative Income
Income Hypothesis?
Hypothesis?
People consume according to their
relative position in society,
consistent with the idea that the
MPC remains fairly constant as
national income increases
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What
What is
is the
the Permanent
Permanent
Income
Income Hypothesis?
Hypothesis?
A person’s consumption
spending is related to his
or her permanent income

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 What
What is
is
Permanent
Permanent Income?
Income?
The regular income a person
expects to earn annually

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Who
Who is
is Milton
Milton Friedman?
Friedman?
An economists who won
the Nobel Prize in
Economics in 1976

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 What
What is
is Friedman’s
Friedman’s
contribution
contribution to
to Income
Income
Hypothesis?
Hypothesis?
People distinguish between
their regular income and
income they expect to make
or lose in any one year
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 Who
Who is
is
Franco
Franco Modigliani?
Modigliani?
An economists who won
the Nobel Prize in
Economics in 1985

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 What
What is
is Modigliani’s
Modigliani’s
Life
Life Cycle
Cycle Hypothesis?
Hypothesis?
Typically, a person’s MPC
is relatively high during
young adulthood,
decreases during middle
age, and then increases
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 What
What can
can cause
cause aa shift
shift in
in
the
the Consumption
Consumption Function?
Function?
• Real assets & money holdings
• Expectations of price changes
• Credit & interest rates
• Taxation

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Real Consumption
C1
C 2

Real Disposable Income

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 For
For more
more information
information
on
on income
income data:
data:
http://www.census.gov/hhes/www/
income.html
http://www.bea.doc.gov/bea/dn/pit
bl.htm
http://www.bls.gov/eag.table.html

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Will
Will aa change
change in
in Income
Income
cause
cause aa shift
shift in
in C?
C?
No! When income changes
there is a movement along
a stationary Consumption
Function Curve

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 B
Real Consumption
Consumption
A Income Line

Real Disposable Income

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 What
What is
is
Intended
Intended Investment?
Investment?
Investment spending
that producers intend
to undertake, on plant,
tools, construction,
and inventory
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 What
What is
is
Autonomous
Autonomous Investment?
Investment?
Investment that is
independent of the
level of income

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Investment

I
45o

National Income
373
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 What
What determines
determines
Autonomous
Autonomous Investment?
Investment?
• Level of technology
• Interest rate
• Expectations of growth
• Rate of capacity utilization
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Consumption, Saving

(C+I)
C

45o

National Income
393
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Why
Why is
is Investment
Investment Volatile?
Volatile?
Because what can change
investors expectations is
unpredictable sometime

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• What determines Consumption?
• What is Keynes’ Absolute Income
Hypothesis?
• What is MPC?
• What happens to MPC as income in
creases?
• What did Kuznets say in his book?
• What is Duesenberry’s Relative
Income Hypothesis?
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• What is the Permanent Income
Hypothesis?
• What is Friedman’s contribution to
Income Hypothesis?
• What is Modigliani’s Life Cycle
Hypothesis?
• What is Autonomous Consumption?
• What is Saving?
• What is the MPS?
• What is Autonomous Investment?
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END
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