2. CHAPTER OVERVIEW
• Identify the consumption & savings functions: what
influences them?
• What are the non income determinants of consumption &
savings?
• What influences shifts and movement along a function?
• What is the relationship between interest rate &
investment?
• What causes shifts in the Investment Demand Curve?
• What is the multiplier and what effect does it have?
3. INCOME-CONSUMPTION AND
INCOME-SAVINGS RELATIONSHIPS
• By studying the Income & Consumption relationship we are
also studying the income & saving relationship
• Savings means “not spending” to an economist
• Savings = DI (disposable income) – C (consumption)
• Although many factors contribute to a nation’s level of
consumption or savings, DI is the most significant!!!!!!
• 45°line for reference
• C = DI on the Line
4. INCOME AND CONSUMPTION
Consumption (billions of dollars)
10000
9000
05
45° Reference Line
C=DI
8000
04
03
7000
00
02
01
C
99
6000
Saving
In 1992
5000
4000
3000
83
2000
84
97
91
90
89
88
87
86
85
98
96
95
94
93
92
Consumption
In 1992
1000
45°
0
0
2000
4000
6000
8000
10000
Disposable Income (billions of dollars)
Source: Bureau of Economic Analysis
5. INCOME-CONSUMPTION AND
INCOME-SAVINGS RELATIONSHIPS
• The Consumption Schedule
• Also called the Consumption Function (CF), reflects
the direct consumption-disposable income
relationship (this is based on historical data)
• The CF shows the trend that as households have
more DI they have a tendency to spend more;
however, households with smaller DI spend a larger
portion then households who have a larger DI
6. INCOME-CONSUMPTION AND
INCOME-SAVINGS RELATIONSHIPS
• The Saving Schedule
• Shows the amount of savings per DI levels
• Households with larger DI can save a greater
portion of their DI
• What does “dissaving” refer to?
• What does the “break-even” income refer to?
7. CONSUMPTION AND SAVING
(1)
(4)
(5)
(6)
(7)
Level of
Average
Average
Marginal
Marginal
(2)
Output
Propensity Propensity Propensity Propensity
Consump(3)
And
to Consume to Save
to Consume to Save
tion
Saving (S)
Income
(APC)
(APS)
(MPC)
(MPS)
(C)
(1) – (2)
(GDP=DI)
(2)/(1)
(3)/(1)
Δ(2)/Δ(1)
Δ(3)/Δ(1)
(1) $370
$375
$-5
1.01
-.01
(2)
390
390
0
1.00
.00
(3)
410
405
5
.99
.01
(4)
430
420
10
.98
.02
(5)
450
435
15
.97
.03
(6)
470
450
20
.96
.04
(7)
490
465
25
.95
.05
(8)
510
480
30
.94
.06
(9)
530
495
35
.93
.07
(10) 550
510
40
.93
.07
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
.75
.25
8. Consumption (billions of dollars)
CONSUMPTION AND SAVING
500
C
475
450
425
Saving $5 Billion
400
Consumption
Schedule
375
Dissaving $5 Billion
Saving
(billions of dollars)
45°
370 390 410 430 450 470 490 510 530 550
Disposable Income (billions of dollars)
50 Dissaving
Saving Schedule
S
$5 Billion
25
Saving $5 Billion
0
370 390 410 430 450 470 490 510 530 550
9. INCOME-CONSUMPTION AND
INCOME-SAVINGS RELATIONSHIPS
• What does Average and Marginal Propensities refer to and
why are they important?
• Average Propensity to Consume (APC)
• The % of total income consumed
• APC = C / I
• Average Propensity to Save (APS)
• The % of total income saved
• APS = S / I
• APS + APC = 1
10. INCOME-CONSUMPTION AND
INCOME-SAVINGS RELATIONSHIPS
• Marginal Propensity to Consume
• MPC = the % of “additional” income consumed
• MPC = change in C / change in income
• Marginal Propensity to Save
• MPS = the % of “additional” income saved
• MPS = change in S / change in income
• MPC + MPS (will always) = 1
MPC and MPS measure slopes
11.
12. INCOME-CONSUMPTION AND
INCOME-SAVINGS RELATIONSHIPS
• Nonincome Determinants of C and S
• Although DI is the most important factor for our
spending and saving, “nonincome determinants”
also influence us.
• These are wealth, expectations, real interest rates,
household debt and taxes.
• Wealth: the value of real and financial assets
• When events boost the “value” of existing
wealth, households increase their spending
and reduce savings.
13. INCOME-CONSUMPTION AND
INCOME-SAVINGS RELATIONSHIPS
• Nonincome Determinants of C and S (continued)
• Expectations: household views of their future income
and the price level affect their spending and saving
decisions
• Real interest rates: when real interest rates fall,
households tend to borrow more, consume more and
save less
• Household Debt: households increase consumption
by acquiring more debt, up to a point.
• Taxation: an increase in taxes will cause a downward
shift in both consumption and savings
14.
15.
16. INCOME-CONSUMPTION AND
INCOME-SAVINGS RELATIONSHIPS
• Terminology, Shifts and Stability
• Movement along a C or S schedule (function) means
a change in relation to DI
• Upward or downward shifts in C or S schedules is
due to a change in one or more of the 5 non income
determinants
• Changes in wealth, expectations, real interest rates
and household debt will cause C and S schedules to
shift in opposite directions!!!!
17. INCOME-CONSUMPTION AND
INCOME-SAVINGS RELATIONSHIPS
• Terminology, Shifts and Stability
• A change in taxes will cause C and S schedules to
shift in the same direction!!!
• Although changes in non income determinants can
shift the C and S schedules, there is generally more
stability in them because households make “longterm” decisions, and don’t usually react immediately
to changes caused by the non income determinants
