Robert F. Mulligan WESTERN CAROLINA UNIVERSITY COLLEGE OF BUSINESS Department of Economics, Finance, & International Business

MBA 505 ECONOMICS AND PUBLIC POLICY

Chapter 22 CONSUMPTION AND INVESTMENT

Key Words

consumption function	induced consumption	average propensity to save (APS)
saving function	marginal propensity to consume (MPC)	wealth
dissaving	marginal propensity to save (MPS)	marginal propensity to import (MPI)
autonomous consumption	average propensity to consume (APC)

1. Consumption and Saving

Households can consume, save, or pay taxes with their income. Consumption spending depends on the level of disposable income. Autonomous consumption is the level of consumption that is not related to income. How much would people consume if they had zero income? (Imagine the zero income condition was temporary.) If disposable income were zero, this would be funded by borrowing. This condition is called dissaving. The marginal propensity to consume is the ratio of the change in consumption spending to the change in disposable income. The MPC is the slope of the consumption function. The marginal propensity to save is the ratio of the change in saving to the change in disposable income. Since disposable income already has taxes removed, MPC + MPS = 1.

Income consumed satisfies current wants; income saved is available to satisfy future wants.

The average propensities to consume and to save, APC & APS, are the amount of consumption spending or saving divided by disposable income.

Consumption and saving are determined by disposable income, wealth, expectations, and demographics.

2. Investment

We assume, somewhat unrealistically, investment is independent of real GDP or autonomous. Investment is so volatile it is not closely related to real GDP - it is the most variable component of real GDP. The level of investment depends on the interest rate, or return on investment, the expectations of firms earning profits, technological change, the cost of capital goods, and capacity utilization

3. Government Spending

Government spending is partly discretionary and partly non-discretionary. Because of the government's ability to borrow, G is not dependent on tax revenues. G is not dependent on real GDP.

4. Net Exports

Net exports equals exports minus imports. Exports depend on foreign income, tastes, foreign price levels, government trade restrictions, and exchange rates, but not on current domestic income. Imports depend on domestic tastes, trade restrictions, and exchange rates, but also on domestic income. The Marginal Propensity to Import (MPI) is the change in imports divided by the change in domestic income.

5. The Aggregate Expenditures Function

AE = C + I + G + X

Equilibrium Real GDP occurs when planned aggregate real expenditures equals actual real aggregate expenditures (in other words equals real GDP). This is where the AE curve crosses the 45 degree line.