AP MACRO Chapter 9 Basic Macro Relationships Personal Savings=DI- Consumption Factors that Determine Savings DI As DI declines---S declines 45 degree.

AP MACRO

Chapter 9

Basic Macro Relationships

Personal Savings=DI-Consumption

Factors that Determine SavingsDIAs DI declines---S declines45 degree reference lineC=DISavings=amount by which actual C

falls short of 45 degree line

Co

nsu

mp

tio

nS

avin

g

o

o45

o

C

S

Consumptionschedule

Savingschedule

C

S

Disposable Income

Disposable Income

SAVING

SAVING

DISSAVING

DISSAVING

MPC = Slope of C

MPS = Slope of S

MPC + MPS = 1

CONSUMPTION AND SAVING

PROPENSITIES

APC + APS=1Consumption/DISavings/DI

MPC + MPS=1Change in C/Change in DIChange in S/change in DI

Non-Income Determinants of C & S

1-wealth Real assets vs. financial assets Usually—if wealth increases-----C moves up; S down

2-expectations Expect recession---- Expect prices to rise tomorrow---

3-real interest rates If you borrow more---Consume more—save less At low interest rates—less incentive

4-household debt As % of DI Held constant when drawing C schedule If consumers increase debt---increase C more at each level

5-taxes Shift both C and S

Co

nsu

mp

tio

nS

avin

g

o

o45

o

C0

S0

Disposable Income

Disposable Income

C1

S1

TERMINOLOGY, SHIFTS, & STABILITY

Increases inConsumptionMeans…

A DecreaseIn Saving

Co

nsu

mp

tio

nS

avin

g

o

o45

o

C0

S0

Disposable Income

Disposable Income

C2

S2

TERMINOLOGY, SHIFTS, & STABILITY

Decreases inConsumptionMeans…

An IncreaseIn Saving

Terminology

Change in amount consumed---move pt. to ptCaused by a change in GDP or

income Change in determinant

Redraw the entire graph

Interest rate investment relationship

Business—plants/inventory MC=interest rate paid for borrowing Vs. MB=expected rate of return on

investment

1st key determinant of Investment Spending 1-expected rate of return=profit Profit/cost Example:

Spend $10,000Make $12,000 net revenue

• Profit=2,000

• 2,000/10,000=20% rate of return• Rate of return=r

2nd determinant

Real rate of interest (i) Financial cost of borrowing Example:

If interest rate is 7% on $10,000• $700 interest cost• Compare to expected rate of return• $2,000-700=$1300 profit• r>i up to the point that r=i

Key concerns

What if the company is NOT borrowing?Opportunity cost

Real interest rate not nominal

Investment (billions of dollars)

Ex

pe

cte

d r

ate

of

retu

rn,

r,a

nd

inte

res

t ra

te, i

(pe

rce

nts

) 16

14

12

10

8

6

4

2

0

INVESTMENTDEMAND

CURVE

5 10 15 20 25 30 35 40

I D

Interest Rate – InvestmentRelationship

What makes Investment Demand Shift?

1-acquisition, maintenance & operating costs

2-business taxes 3-technological change 4-stock of capital goods in hand 5-expectations

Investment-most volatile part of GDP

1-durability 2-irregularity of innovation 3-variability of profits 4-variability of expectations