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Business Economics (ECO 341)Fall: 2012 Semester
Khurrum S. Mughal
1
YearPrice ofHot dogs
Quantity ofHot dogs
Price of Hamburgers
Quantity ofHamburgers
2001 $1 100 $2 50
2002 $2 150 $3 100
2003 $3 200 $4 150
Quiz
Consumption, Saving and Investment
Macroeconomics
Consumption
Savings
Investment
Multiplier Effect
Theme of Lecture
Importance of Consumptions, Savings and Investments for a country
The choice between Consumption and Investment defines the future direction of an economy
Personal Consumption Expenditure is on final goods and services by households
What is not consumed from the disposable income is saved.
Macroeconomics
Consumption and Saving Pattern for 2010-11, PBS
Major differences in Pakistan
◦ In Income Class
◦ Due to Provincial, hence cultural differences
◦ Urban or Rural Life style
Difference in Consumption Patterns
AssignmentGo to
http://www.pbs.gov.pk/content/pakistan-social-and-living-standards-measurement◦ Household economic Survey (HES)
Difference in Consumption Saving Patterns
Punjab Sindh KPK BalochistanTotal Urban Rural Total Urban Rural Total Urban Rural Total Urban Rural
Difference in Consumption Patterns
The Keynesian Theory of Consumption:
Current real disposable income is the most important determinant of consumption in the short run.
Disposable Income (Yd) = Gross Income - (Deductions from Direct Taxation + Benefits)
Consumption Function
Gross income (Y) can either be consumed (C), Saved (S), or given to the Government in taxes (T)
Y = C + S + T Yd = Yg – T
Consumption Function
Savings
45˚
Y
C
0
Consumption function C = f(Y)
Consumption
Y1 Y 2
CA
Consumption Function
The standard Keynesian consumption function:
C = a + c Yd where,Yd= Disposable incomeC= Consumer expenditurea = autonomous consumption. c = marginal propensity to
consume (mpc). Y
C
0
C = f(Y)
Savings
Consumption
45˚
Y1 Y 2
CA
Consumption Function
• If an individual's income fell to zero some of his existing spending could be sustained by using savings. This is known as DIS-SAVING.
The gradient of the consumption curve gives the marginal propensity to consume. As income rises, so does total consumer demand.
Break-even Point
Y
C
0
C = f(Y)
Savings
Consumption
45˚
Y1 Y 2
CA
Consumption Function
The nineteen century Prussian statistician Ernst Engel (1821–1896) noticed
as income increases, expenditures on many items go up, but there are limits to the extra money people will spend on food when their income rise.
Engel's Law: The proportion of total spending devoted to food declines as income increases.
Engel's Law
Nonlinear Consumption function
Y
C
C = f(Y)
CA
45°
E
YE
Current disposable income: it is the central factor determining a nation's consumption.◦Permanent-Income theory◦Life-Cycle Hypothesis
Wealth Effect
Expectations (interest rate, inflation, etc)
Determinants of Consumption
Consumption
Savings
Investment
Multiplier Effect
Theme of Lecture
Saving is that part of income that is not consumed. Saving equals income minus consumption: S = Y – C
Income is the sum of consumption and savings: Y = C + S
Savings
Like consumption, Saving is also a function of income: S = f(Y)
If autonomous consumption exists then autonomous saving exists as well and saving function is:
S = -CA + s.Y
Saving is a source for investment.
Savings Function
Like consumption, Saving is also a function of income: S = f(Y)
If autonomous consumption exists then autonomous saving exists as well and saving function is:
S = -CA + s.Y
Saving is a source for investment.
Savings Function
Y
C, S
0
C = f(Y)
45˚
Y E
CA
-CA
S = f(Y)
The saving function is the mirror image of the consumption function. It shows the relationship between the level of saving and income.
Savings Function
The marginal propensity to save
is defined as the fraction of an extra unit of income that goes to extra saving.
Y
SMPS
Savings
Calculating MPC & MPS
Income Category
DI ($) Consumption Exp
MPC Net Savings
MPS
A 24,000 24,200 ? ? ?
B 25,000 25,000 ? ? ?
C 26,000 25,800 ? ? ?
D 27,000 26,600 ? ? ?
E 28,000 27,400 ? ? ?
F 29,000 28,200 ? ? ?
G 30,000 29,000 ? ? ?
Calculating MPC & MPS
Income Category
DI ($) Consumption Exp
MPC Net Savings
MPS
A 24,000 24,200 -200
B 25,000 25,000 0.80 0 0.20
C 26,000 25,800 0.80 200 0.20
D 27,000 26,600 0.80 200 0.20
E 28,000 27,400 0.80 200 0.20
F 29,000 28,200 0.80 200 0.20
G 30,000 29,000 0.80 200 0.20
How much of every additional rupee in income is consumed? MPC
How much of every additional rupee in income is saved? MPS
MPC + MPS = 1 (IDENTITY)
Identity of Marginal Propensities
Consumption
Savings
Investment
Multiplier Effect
Theme of Lecture
Meaning of Investment in Economics
Investment plays two roles in macroeconomics:
◦ It can have a major impact on Aggregate Demand and affects business cycles
◦ It leads to capital accumulation
Focusing on Gross private Domestic Investment
Investment
Revenues: an investment should bring the firm additional revenue.
Costs: interest rates & taxes influences the costs of the investment.
Consumer demand: the bigger the increase in consumer demand, the more investment will be needed.
Expectation: business expectation about future state of economy.
Determinants of Investment
Investment spending
Interest rate i
D
D1
Higher Output
The Investment Demand Curve
Investment spending
Interest rate i
D1
D
Higher Taxes
The Investment Demand Curve
Investment spending
Interest rate i
D1
D
Pessimistic Expectation
The Investment Demand Curve
Consumption
Savings
Investment
Multiplier Effect
Theme of Lecture
The Keynesian investment multiplier
model shows that an increase in investment will increase output by a multiplied amount – by an amount greater than itself.
The multiplier is the number by which the change in investment must be multiplied in order to determine the resulting change in total output.
Investment Multiplier
Y
C, I
0
45˚
C +I1
C + I2
Y1
I2 = I
1 + ΔI
ΔY = k . ΔI
Y2
ΔY
ΔI
E1
E2
I
Yk
Investment Multiplier
When there is change in C , I , G or Xn either
increases or decreases, real GDP also increases/decreases.
Total increase in real GDP is larger than the initial increase in spending.
The MULTIPLIER is the amount by which a change in any component of spending is magnified or multiplied to determine the change that it generates in real GDP.
Multiplier
A change in spending ultimately changes output and income by more than the initial change in investment spending. This is called the multiplier effect.
The Multiplier Effect
The size of the multiplier k depends upon how large the MPC is.
MPSMPCYCCY
Y
I
Yk
1
1
1
1
1
Investment Multiplier
The Spending Multiplier can be calculated from the MPC or the MPS.
Multiplier = 1/1-MPC or 1/MPS
Multipliers are (+) when there is an increase in spending and (–) when there is a decrease in spending
You multiply the multiplier times the initial increase in spending to determine total effect on real GDP.
Investment Multiplier
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