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Principles of Economics 2nd edition by Fred M Gottheil PowerPoint Slides prepared by Ken Long ©1999 South-Western College Publishing 1 Chapter 21 Consumption & Investment 5/23/2017 ©1999 South-Western College Publishing 2 This chapter discusses principles associated with The Keynes’ Modigliani’s Marginal Absolute Propensity Life-Cycle Income to Duesenberry’s Friedman’s Permanent Relative Income Income TheAutonomous Case for Income Investment Inequality Hypothesis Hypothesis to Consume Save ©1999 South-Western College Publishing 3 What determines Consumption Spending? Consumption is a relationship between consumption and income C = F(Y) ©1999 South-Western College Publishing 4 Who was John Maynard Keynes? Economist who had a book published in 1936 named “The General Theory of Employment, Interest and Money” ©1999 South-Western College Publishing 5 What did Keynes say in his book? The economy could tend toward a less than full employment equilibrium ©1999 South-Western College Publishing 6 Why was this thought different? The Classical Economists believed that the economy is always tending toward a full employment equilibrium ©1999 South-Western College Publishing 7 Who is correct, Keynes or the Classical Economists? Keynes is correct in the short run, the Classical Economists are correct in the long run ©1999 South-Western College Publishing 8 What is Keynes’ Absolute Income Hypothesis? As national income increases, consumption spending increases, but by diminishing amounts ©1999 South-Western College Publishing 9 What happens to the Marginal Propensity to Consume as income increases? MPC decreases as income increases and increases as income decreases ©1999 South-Western College Publishing 10 For more information on income 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 ©1999 South-Western College Publishing 11 What is MPC? Change in consumption brought about by a change in income ©1999 South-Western College Publishing 12 ©1999 South-Western College Publishing 13 If household's income rises from $12,000 to $12,700 and consumption rises from $13,000 to $13,500, then MPC = $500 / $700 = .71 ©1999 South-Western College Publishing 14 Real Consumption The Consumption Function C DC D DI Real Disposable Income ©1999 South-Western College Publishing 15 Who was Simon Kuznets? An economists who published a book in 1941 named “National Income and Its Composition” ©1999 South-Western College Publishing 16 What did Kuznets say in his book? MPC tends to remain fairly constant regardless of the absolute level of national income ©1999 South-Western College Publishing 17 What is Duesenberry’s Relative Income Hypothesis? As national income increases, consumption spending increases as well, always by the same amount ©1999 South-Western College Publishing 18 What is Permanent Income? The regular income a person expects to earn annually ©1999 South-Western College Publishing 19 What is the Permanent Income Hypothesis? A person’s consumption spending is related to his or her permanent income ©1999 South-Western College Publishing 20 Who is Milton Friedman? An economists who won the Nobel Prize in Economics in 1976 ©1999 South-Western College Publishing 21 What is Friedman’s contribution to Income Hypothesis? People distinguish between their regular income and income they expect to make or lose in any one year ©1999 South-Western College Publishing 22 Who is Franco Modigliani? An economists who won the Nobel Prize in Economics in 1985 ©1999 South-Western College Publishing 23 What is Modigliani’s Life Cycle Hypothesis? Typically, a person’s MPC is relatively high during young adulthood, decreases during middle age, and then increases ©1999 South-Western College Publishing 24 What is Autonomous Consumption? Consumption spending that is independent of the level of income ©1999 South-Western College Publishing 25 What is significant about Autonomous Consumption? Even when income is zero, autonomous spending is positive ©1999 South-Western College Publishing 26 What can cause a shift in the Consumption Function? • Real assets & money holdings • Expectations of price changes • Credit & interest rates • Taxation ©1999 South-Western College Publishing 27 Real Consumption 1 C C2 Real Disposable Income ©1999 South-Western College Publishing 28 Will a change in Income cause a shift in C? No! When income changes there is a movement along a stationary Consumption Function Curve ©1999 South-Western College Publishing 29 Real Consumption B A Consumption Income Line Real Disposable Income ©1999 South-Western College Publishing 30 What is the Consumption Equation? C = a + bY Income Autonomous Consumption MPC ©1999 South-Western College Publishing 31 What is Saving? That part of national income not spent on consumption ©1999 South-Western College Publishing 32 What is the Marginal Propensity to Save? The change in saving induced by a change in income ©1999 South-Western College Publishing 33 ©1999 South-Western College Publishing 34 MPC + MPS … must equal one whole ©1999 South-Western College Publishing 35 Consumption, Saving Consumption Function Equilibrium 45o National Income ©1999 South-Western College Publishing 363 What is Intended Investment? Investment spending that producers intend to undertake ©1999 South-Western College Publishing 37 What is Autonomous Investment? Investment that is independent of the level of income ©1999 South-Western College Publishing 38 What determines Autonomous Investment? • Level of technology • Interest rate • Expectations of growth • Rate of capacity utilization ©1999 South-Western College Publishing 39 Consumption, Saving 45o National Income 404 What determines the level of Investment? The rate of interest and expectations ©1999 South-Western College Publishing 41 Why is Investment Volatile? Because what can change investors expectations is unpredictable sometime ©1999 South-Western College Publishing 42 • What determines Consumption? • What is Keynes’ Absolute Income Hypothesis? • What is MPC? • What happens to MPC as income increases? • What did Kuznets say in his book? • What is Duesenberry’s Relative Income Hypothesis? 43 • 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? 44 END ©1999 South-Western College Publishing 45