Chapter 8
8BasicMacroeconomicRelationships
Copyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show1Chapter ObjectivesHow Changes in Income Affect
Consumption (and Saving)About Factors Other Than Income That Can
Affect ConsumptionHow Changes in Real Interest Rates Affect
InvestmentAbout Factors Other Than the Real Interest Rate That Can
Affect InvestmentWhy Changes in Investment Increase or Decrease
Real GDP by a Multiple AmountCopyright 2008 The McGraw-Hill
Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd
Show2Income-Consumption and Income-Savings
RelationshipsRelationship b/w income and savingPersonal saving =
DI-C (disposable income-consumption)Most significant factor in
determining nations level of C and S is DI45 degree line is a
reference line b/c it bisects the 90 degree angle formed by the 2
graph axesDot on line represents C and DI in for one yearCopyright
2008 The McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome
and ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show4Consumption
and SavingMPC + MPS = 1MPC and MPS as SlopesNonincome Determinants
of Consumption and SavingWealth EffectExpectationsReal Interest
RatesHousehold Debt
W 8.1Copyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show15The Consumption ScheduleHypothetical consumption
scheduleShows various amounts that households would plan to consume
at each of the various levels of DI that might prevail at some
specific timeIn aggregate:Households inc. spending as DI incSpend a
larger proportion of a small DI than of a large DICopyright 2008
The McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show7The Saving
ScheduleTo find amount saved, subtract C from DI (S=DI-C)Direct
relationship b/w saving and DISaving is a smaller proportion of a
smaller DI than of a large DIDissaving (consuming in excess of
after-tax income) will occur at relatively low DisCopyright 2008
The McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show8Break-Even
IncomeBreak-even income: income level at which households plan to
consume their entire incomesGraphically:Consumption schedule cuts
the 45 degree lineSaving schedule cuts the horizontal axis (saving
is zero)Copyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show9Average and Marginal PropensitiesAverage propensity
to consume: fraction or % or total income that is
consumedAPC=consumption/incomeAverage propensity to save-fraction
of total income that is savedAPS=saving/incomeAPS+APC = 1Copyright
2008 The McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome
and ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show10Consumption
and Saving(1)Level
ofOutputAndIncome(GDP=DI)(2)Consump-tion(C)(3)Saving
(S)(1-2)(4)AveragePropensityto
Consume(APC)(2)/(1)(5)AveragePropensityto
Save(APS)(3)/(1)(6)MarginalPropensityto
Consume(MPC)(2)/(1)(7)MarginalPropensityto Save(MPS)(3)/(1)$370 390
410 430 450 470 490 510 530
550$375390405420435450465480495510$-505101520253035401.011.00.99.98.97.96.95.94.93.93-.01.00.01.02.03.04.05.06.07.07.75.75.75.75.75.75.75.75.75.25.25.25.25.25.25.25.25.25Copyright
2008 The McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome
and ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd ShowBasic
RelationshipsIncome-ConsumptionIncome-Saving45 LineC = DI on the
LineS = DI - C
Copyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show3Income and Consumption
Consumption (billions of dollars)Disposable Income (billions of
dollars)Consumption and Disposable Income, 1983-200545 Reference
LineC=DI8386858488899190879293949501979699980002050304ConsumptionIn
1992SavingIn 199245CCopyright 2008 The McGraw-Hill
Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd ShowConsumption
and SavingThe Consumption ScheduleThe Saving ScheduleBreak-Even
IncomeAverage Propensity to Consume (APC)Average Propensity to Save
(APS)
O 8.1APS =SavingIncomeAPC =ConsumptionIncomeCopyright 2008 The
McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show3. Real
Interest Rates when interest rates fall, people spend more save
less and vice versa
4. Household debt increased borrowing shifts C curve upward and
vice cersaCopyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show1745Consumption and SavingConsumption and Saving
SchedulesC0S0Disposable Income (billions of dollars)Consumption
(billions of dollars)Saving(billions of dollars)C2C1S1S2Copyright
2008 The McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome
and ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd ShowInterest Rate
and InvestmentExpected Rate of Return (r)The Real Interest Rate (i)
Meaning of r = iInvestment Demand Curve
O 8.2G 8.2
Copyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show20Interest Rate and InvestmentExpectedRate ofReturn
(r)CumulativeAmount ofInvestmentHaving ThisRate ofReturn or
Higher(i)16%14%12%10%8%6%4%2%0%$ 0510152025303540 r and i
(percent)16141210864205 10 15 20 25 30 35 40 Investment (billions
of dollars)The Investment Demand CurveIDCopyright 2008 The
McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd ShowInterest Rate
and InvestmentShifts of the Investment Demand CurveAcquisition,
Maintenance, and Operating CostsBusiness TaxesTechnological
ChangeStock of Capital Goods on HandExpectationsCopyright 2008 The
McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show25Interest
Rate and Investment
1971 1975 1979 1983 1987 1991 1995 1999 2003 GDPGross
InvestmentThe Volatility of InvestmentPercentage
ChangeYearCopyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show33The Multiplier EffectMultiplier =Change in Real
GDPInitial Change in SpendingThe Multiplier and the Marginal
PropensitiesMultiplier =11 - MPCMultiplier =1MPS-or-Graphically
W 8.2Copyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd ShowSquaring the Economic CircleHumorist Art Buchwald and
the MultiplierOne Person Cant Buy a ProductOthers Subsequently
Impacted and Cannot Buy Other ItemsMultiple Effects Impact
PsycheUltimately Causes Multiple Step Impact Upon the Economy as a
WholeLastWordCopyright 2008 The McGraw-Hill
Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show41Key Terms45
(degree) lineconsumption schedulesaving schedulebreak-even
incomeaverage propensity to consume (APC)average propensity to save
(APS)marginal propensity to consume (MPC)marginal propensity to
save (MPS)wealth effectexpected rate of returninvestment demand
curvemultiplierCopyright 2008 The McGraw-Hill
Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show42Interest
Rate and Investment r and i (percent)0Investment (billions of
dollars)Shifts in the InvestmentDemand CurveID0ID1ID2Increase in
Investment DemandDecrease in Investment DemandCopyright 2008 The
McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show26Non-Interest
Rate Determinants of Investment DemandInc in investment demand,
shift right Dec in investment demand, shift leftDeterminants:1.
acquisitions, maintenance, and operating costs higher operating
costs shift curve left, vice versaCopyright 2008 The McGraw-Hill
Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show272. business
taxes taxes inc, investment demand curve shifts left, reduction of
bus. Taxes shifts right3. Technological change new technology,
shift right
Copyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show284. stock of capital goods on hand excess productive
capacity decreases demand, vice versa
5. expectations of future sales, political climate, pop growth,
etcif expectations optimistic then investment demand increases and
vice versaCopyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show29Interest Rate and InvestmentInstability of
InvestmentDurabilityIrregularity of InnovationVariability of
ProfitsVariability of ExpectationsCopyright 2008 The McGraw-Hill
Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show30Instability
of InvestmentInvestment is the most volatile component of total
spendingWhy?1. durability indefinite life of capital goods2.
irregularity of innovation difficult to predict the arrival of new
inventions3. variability of profits expectation of future profit is
influenced by current profits4. Variability of expectations
possible changes in business conditionsCopyright 2008 The
McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show31GLOBAL
PERSPECTIVE
Interest Rate and InvestmentSource: World BankGross Investment
Expenditures as aPercent of GDP, Select NationsSouth
KoreaJapanMexicoCanadaFranceUnited StatesGermanyUnited
KingdomSweden0 10 20 30Percent of GDP, 2004 Copyright 2008 The
McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show32The
Multiplier EffectThis will be discussed again in Ch. 9Direct
relationship b/w changes in spending and changes in real GDPThe
multiplier effect a change in a component of total spending leads
to a larger change in GDPSee formula on previous slideCopyright
2008 The McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome
and ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show35The
Multiplierinitial change in spending usually deals with investment,
but could also include G,C or NXChange in spending results from
change in real interest rate or shifts in the investment demand
curveMultiplier works in both directions (inc/dec)Copyright 2008
The McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show36Rationale1.
economy supports repetitive and continuous flows of income and
expenditures2. any change in income will alter consumption and
spending in the same direction as the change in income- any change
in income will set off a spending chain throughout economyCopyright
2008 The McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome
and ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show37The
Multiplier and Marginal PropensitiesMPC and multiplier are directly
relatedMPS and multiplier are inversely relatedMultiplier = 1/1-MPC
orMultiplier = 1/MPSCopyright 2008 The McGraw-Hill
Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd ShowThe Multiplier
Effect(1)Change inIncome(2)Change inConsumption(MPC = .75)(3)Change
inSaving(MPC = .25)Increase in Investment of $5Second RoundThird
RoundFourth RoundFifth RoundAll other rounds Total$
5.003.752.812.111.584.75$ 20.00$ 3.752.812.111.581.193.56$ 15.00$
1.25.94.70.53.391.19$ 5.00Tabular and Graphical ViewsRounds of
Spending12345All$20.0015.2513.6711.568.755.00$5.00$3.75$2.81$2.11$1.58$4.75I=$5
billionCopyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd Show39The Multiplier EffectThe MPC and the
Multiplier105432.5.67.75.8.9MPCMultiplierCopyright 2008 The
McGraw-Hill Companies8-#8ChapterBasic RelationshipsIncome and
ConsumptionConsumption and SavingConsumption and Saving
SchedulesChanges in C & SInterest Rate and InvestmentInvestment
Demand CurveShifts in the Investment Demand CurveVolatility of
InvestmentMultiplier EffectLast WordKey TermsEnd Show40Next Chapter
PreviewChapter 9! The AggregateExpenditures Model
Copyright 2008 The McGraw-Hill Companies8-#8ChapterBasic
RelationshipsIncome and ConsumptionConsumption and
SavingConsumption and Saving SchedulesChanges in C & SInterest
Rate and InvestmentInvestment Demand CurveShifts in the Investment
Demand CurveVolatility of InvestmentMultiplier EffectLast WordKey
TermsEnd
Show43Chart12374.82597.32829.33016.73216.93475.83734.53986.44140.14385.44627.94902.45157.354605770.56119.16536.47025.67354.57645.37996.38512.59072.1
Consumption
Sheet1DIConsumption19832608.42374.8198429122597.319853109.32829.319863285.13016.719873458.33216.919883748.73475.819894021.73734.519904285.83986.419914464.34140.119924751.44385.419934911.94627.919945151.84902.419955408.25157.319965688.5546019975988.85770.519986395.96119.1199966956536.4200071947025.620017468.87354.520027830.17645.320038169.27996.320048664.28512.520059038.69072.1
Sheet100000000000000000000000
Consumption
Sheet2
Sheet3