Download Module Income and Expenditure

Module 16
Income and
Expenditure
Use a
Picture
of a
retiree
here
KRUGMAN'S
MACROECONOMICS for AP*
Margaret Ray and David Anderson
What you will learn
in this Module:
• The nature of the multiplier, which shows how
initial changes in spending lead to further
changes
• The meaning of the aggregate consumption
function, which shows how current disposable
income affects consumer spending
• How expected future income and aggregate
wealth affect consumer spending
• The determinants of investment spending
• Why investment spending is considered a
leading indicator of the future state of the
economy
The Multiplier: An Informal
Introduction
• Marginal Propensity to
Consume (MPC)
• Marginal Propensity to
Save (MPS)
MPC = ∆ Consumer Spending
∆ Disposable Income
MPS =
∆ Saving
∆ Disposable Income
MPC + MPS = 1
MPC = 1 - MPS
MPS = 1 - MPC
Thus the MPC = (Δ C/Δ Yd) = .8 and
The MPS = (Δ S/Δ Yd) = .20.
So if this household receives $1 of additional Yd, they will
consume 80 cents and save 20 cents of it
The Multiplier: An Informal
Introduction
• Autonomous Change in
Aggregate Spending (AAS)
• Multiplier
1
∆Y = _________
X ∆AAS
(1 - MPC)
Multiplier =
_____
∆Y = _________
1
∆AAS (1 - MPC)
The multiplier is the ratio of the total change in real GDP
caused by an autonomous change in aggregate spending
to the size of that autonomous change.
The Multiplier: An Informal
Introduction
• Ted is a chicken farmer in the local community.
• Suppose Ted decides to spend $1000 on some chicken
coops at Anthony’s farm supply shop. This money now
starts to be circulated around the economy.
•
• 1. Anthony now has $1000 from the sale and spends 80%
($800) on clothes at Marcia‘s boutique.
• 2. Marcia now has $800 from the sale and spends 80%
($640) to fix her car at Pat’s garage.
• 3. Pat now has $640 from the sale and spends 80% ($512)
at Dianna’s grocery store.
• 4. Dianna now has $512 from the sale and spends 80%
($409.60) with Catherine’s catering company.
The Multiplier: An Informal
Introduction
• After 5 rounds of spending, we’ve created $2361.60, more
than DOUBLE the original injection of spending!!!!! If we
had continued until someone was trying to spend 80% of
nothing, Ted’s initial $1000 purchase would have
multiplied to a total of $5000 in income/spending.
The spending multiplier can be shown to be equal to:
M = 1/(1-MPC) = 1/(1-.80) = 1/.2 = 5
Since MPC + MPS = 1, we can also say that M=1/MPS
Current Disposable Income and
Consumer Spending
•Relationship between Disposable Income and
Consumer Spending
Consumption Function
Generally the consumption function is modeled:
c = a + MPC yd
Using the hypothetical information from the table above:
c = 5 + .80Yd
•If Yd increases from $10 to $20, C increases from $13 to $21.
What Causes Shifts of the
Aggregate Consumption Function?
•Changes in Expected Future Disposable
Income
• Permanent Income Hypothesis
•Changes in Aggregate Wealth
• Life-cycle Hypothesis
Investment Spending
• Planned Investment
Although consumer
spending is much larger
than investment
spending, booms and
busts in investment
spending tend to drive
the business cycle. In
fact, most recessions
originate as a fall in
investment spending.
The Interest Rate and
Investment Spending
r
r’
I
A decrease
in the real
interest rate
will result in
more gross
private
investment
I’
eve
Expected Future Real GDP, Production
Capacity, and Investment Spending
r
I
An increase
in either
expected
future real
GDP or
production
capacity will
result in
more
investment at
the same
interest rate
I’
Unnumbered Table 16.1 The Multiplier and the Great
Depression
Ray and Anderson: Krugman’s Macroeconomics for AP, First
Edition
Copyright © 2011 by Worth Publishers
Figure 16.1 Current Disposable Income and Consumer Spending for American Households
in 2008
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Figure 16.2 The Consumption Function
Ray and Anderson: Krugman’s Macroeconomics for AP, First
Edition
Copyright © 2011 by Worth Publishers
Figure 16.3 A Consumption Function Fitted to Data
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Figure 16.4 Shifts of the Aggregate Consumption Function
Ray and Anderson: Krugman’s Macroeconomics for AP, First
Edition
Copyright © 2011 by Worth Publishers
Unnumbered Figure 16.1 Interest Rates and the U.S.
Housing Boom
Ray and Anderson: Krugman’s Macroeconomics for AP, First
Edition
Copyright © 2011 by Worth Publishers