Module 16: Income and Expenditure

Spending Multiplier

(Change in GDP)/ (Change in Spending)=1/MPS=1/(1-MPC)

Causes of consuming less and saving more.

1) Decrease in DI 2) Increase in Taxes

Causes of consuming more and saving less.

1) Increase in DI 2) Decrease in Taxes

What things can you do with your after tax income?

1) Spend 2) Save

#1 EXAMPLE MPC & MPS For each person getting a new $1,000, several consumption events will occur from that single amount of money. 1) How long will the pattern continue? Economists use the SPENDING MULTIPLIER FORMULA to estimate the number of times the pattern will repeat before the amount shrinks to a point where new spending stops. FORMULA: 1/1-MPC or 1/MPS x New Spending 2) MPC is .9: How many new dollars of consumption will be created if society receives $1 Million Dollars? 3) How many new dollars of consumption will be created if the MPC is only .5?

1) Until original spending shrinks to zero. 2) 1/.1=10 x 1,000,000=10,000,000 3) 1/.5=2 x 1,000,000=2,000,000

Decision to Invest

A firm invests in projects as long as r>=i

Saving Function

A linear relationship showing how increases in disposable income cause increases in saving.

MPC + MPS

Always = 1.

APC + APS

Always =1.

Dissaving

Another way of saying that saving is less than zero. This can occur at low levels of disposable income when the consumer must liquidate assets or borrow to maintain consumption.

APC

Average of what people will consume. [% or Fraction]

APS

Average of what people will save. [% or Fraction]

[DI]

DI=Y-T

Multiplier Effect

Describes how a change in any component of aggregate expenditures creates a larger change in GDP.

Consumption Function

Equation showing how an individuals household's consumer spending caries with the household's current disposable income.

Determinant of Consumption and Saving

Factors that shift the consumption and saving functions in the opposite direction are wealth, expectations, and household debt. The factors that change consumption and saving functions in the same direction are taxes and transfers.

[DI] Disposable Income

Income consumer has left over to spend or save once he or she has paid out net taxes.

[MPC] Marginal Propensity to Consume

Increase in consumer spending when disposable income rises by $1.00.

[MPS] Marginal Propensity to Save

Increase in household savings when disposable income rises by $1.00.

Autonomous Change in Aggregate Spending

Initial rise or fall in aggregate spending that is the cause, not the result, of a series of income and spending changes.

Investment Demand

Inverse relationship between the real interest rate and he cumulative dollars invested. Like any demand curve, this is drawn with a negative slope.

#1 EXAMPLE MPC & MPS 1) Assume new marginal income is created via a tax cut. 2) Assume that the tax cut averages a new $1,000 of disposable income. 3) Assume that the current MPC will be 90% and the MPS will be 10%. CHART PERSON/MPC/MPS

MPC 90% = .9 MPS 10% =.1 PERSON/MPC/MPS 1) First to get the new /$900/$100 2) Second to use that $/$810/$90 3) Third to use that $/729/$81 4) Fourth to use that $/$656.10/$72.90 5) Fifth to use that $/ $590.49/$65.61 6) Total So Far of the Original $1,000/$3,685.59/$409.51

[MPC]

MPC=Change in C/ Change in DI

[MPS]

MPS=Change in S/ Change in DI

Unplanned Inventory Investment

Occurs when actual sales are less than business expected, leading to unplanned increases inventories. Sales in excess of expectations result in negative unplanned inventory investment.

Private Saving

Saving conducted by households and equal to the different between disposable income and consumption.

Inventories

Stocks of goods held to satisfy future sales.

Actual Investment Spending

Sum of planned investment spending and unplanned inventory investment.

Consumption and Saving Schedules

Tables that show the direct relationships between disposable income and consumption and saving. If DI increases, C and S both Increase.

Autonomous Consumption

The amount of consumption that occurs no matter the level of disposable income. In a linear consumption function, this shows up as a constant and graphically it appears as the y intercept.

Autonomous Consumer Spending

The amount of money a household would spend if it had no disposable income.

Autonomous Saving

The amount of saving that occurs no matter the level of disposable income. In a linear saving function, this shows up as a constant and graphically it appears as the y intercept.

[i] Real Rate of Interest

The cost of borrowing to fund an investment. Can be thought of as a marginal cost of an investment project.

Planned Investment Spending

The investment spending that businesses intend to undertake during a given period.

Autonomous Investment

The level of investment determined by investment demand. It is autonomous because it is assumed to be constant at all levels of GDP.

Market for Loanable Funds

The market for dollars that are available to be borrowed for investment projects. Equilibrium in this market is determined at the real interest rate where the dollars saved (supply) is equal to the dollars borrowed (demand).

Demand for Loanable Funds

The negative relationship between the real interest rate and the dollars invested and borrowed by firms and by the government.

Supply of Loanable Funds

The positive relationship between the dollars saved and the real interest rate.

[r] Expected Real Rate of Return

The rate of real profit the firm anticipates receiving on investment expenditures. This is the marginal benefit of an investment project.

Multiplier

The ratio of the total change in rGDP caused by an autonomous change in aggregate spending to the size of the autonomous change.

Aggregate Consumption Function

The relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending.

Inventory Investment

The value of the change in total inventories held in the economy during a given period.

Tax Multiplier

Tm=(Change in GDP)/ (Change in Taxes)= MPCxMultplier= MPC/MPS

MPS

What % of new DI people save.

MPC

What % of new DI will people consume.

Balanced Budget Multiplier

When a change in government spending is offset by a change in lump-sum taxes, rGDP changes by the amount of the change in G; the balanced budget multiplier is thus equal to 1.

Effects on loans and the banking system.

[Decrease in Taxes] 1) Increase in Consumption 2) Decrease in Savings 3) Decrease in Loanable Funds 4) Increase in Interest Rates [Increases Taxes] 1) Decrease in Consumption 2) Increase in Savings 3) Increase in Loanable Funds 4) Decrease in Interest Rates