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10 Basic Macroeconomic Relationships McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Income Consumption and Saving • Consumption (C) and Saving (S) • Primarily determined by Disposable Income (DI) • Directly related to DI • Saving = “not spending” LO1 Income, Consumption, and Saving LO1 Income Consumption and Saving • Consumption schedule • Planned household spending at • LO1 different levels of DI Saving schedule • S = DI - C • Planned household saving at different levels of DI Consumption and Saving Schedules TABLE 10.1 Consumption and Saving Schedules (in Billions) and Propensities to Consume and Save (4) (1) Level of Output and Income (GDP=DI) (2) Consumption (C) (3) Saving (S), (1) – (2) (1) $370 $375 $-5 (6) Average Propensity to Consume (APC), Average Propensity to Save (APS), (2)/(1) (7) Marginal Propensity to Consume Marginal Propensity to Save (3)/(1) (MPC), (2)/(1)* (MPS), (3)/(1)* 1.01 -.01 .75 .25 1.00 .00 .75 .25 (5) (dissaving) (2) 390 390 0 (breakeven) (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 Consumption (billions of dollars) Consumption and Saving Schedules 500 C 475 450 425 Saving $5 billion Consumption schedule 400 375 Dissaving $5 billion Saving (billions of dollars) 45° 370 390 410 430 450 470 490 510 530 550 50 25 0 Dissaving Saving schedule S $5 billion Saving $5 billion 370 390 410 430 450 470 490 510 530 550 Disposable income (billions of dollars) LO1 Average Propensities • What is not consumed is saved • Average propensity to consume (APC) • Fraction of total income consumed • Average propensity to save (APS) • Fraction of total income saved consumption APC = income APS = APC + APS = 1 LO1 saving income Consumption and Saving Schedules TABLE 10.1 Consumption and Saving Schedules (in Billions) and Propensities to Consume and Save (4) (1) Level of Output and Income (GDP=DI) (2) Consumption (C) (3) Saving (S), (1) – (2) (1) $370 $375 $-5 (6) Average Propensity to Consume (APC), Average Propensity to Save (APS), (2)/(1) (7) Marginal Propensity to Consume Marginal Propensity to Save (3)/(1) (MPC), (2)/(1)* (MPS), (3)/(1)* 1.01 -.01 .75 .25 1.00 .00 .75 .25 (5) (dissaving) (2) 390 390 0 (breakeven) (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 Marginal Propensities • 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 = change in consumption change in income MPS = MPC + MPS = 1 LO1 change in saving change in income Consumption and Saving Schedules TABLE 10.1 Consumption and Saving Schedules (in Billions) and Propensities to Consume and Save (4) (1) Level of Output and Income (GDP=DI) (2) Consumption (C) (3) Saving (S), (1) – (2) (1) $370 $375 $-5 (6) Average Propensity to Consume (APC), Average Propensity to Save (APS), (2)/(1) (7) Marginal Propensity to Consume Marginal Propensity to Save (3)/(1) (MPC), (2)/(1)* (MPS), (3)/(1)* 1.01 -.01 .75 .25 1.00 .00 .75 .25 (5) (dissaving) (2) 390 390 0 (breakeven) (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 Marginal Propensities C = .75 Consumption 15 MPC = 20 C ($15) Saving DI ($20) MPS = S 5 20 = .25 S ($5) DI ($20) LO1 LO1 Disposable income Interest Rate – Investment Relationship LO4 Investment Decision • Marginal-benefit/Marginal-cost Decision • Marginal-benefit from investment – = expected rate of return • Marginal-cost – = interest rate paid on borrowed funds LO4 Interest Rate and Investment • Guided by profit motive • Expected rate of return (r) – = Expected profit / Cost • Real interest rate (i) – Interest cost of investment • = interest rate x $ borrowed • Invest as long as r ≥ i LO4 Instability of Investment • Variability of expectations • Durability • Irregularity of innovation • Variability of profits LO4 Instability of Investment LO4