ModuleIncome and Expenditure

KRUGMAN'SMACROECONOMICS for AP*

16

Margaret Ray and David Anderson

What you will learnWhat you will learn

in thisin this ModuleModule::• The nature of the multiplier, which shows

how initial changes in spending lead to further changes

• The meaning of the aggregate consumption function, which shows how current disposable income affects consumer spending

• How expected future income and aggregate wealth affect consumer spending

• The determinants of investment spending

• Why investment spending is considered a leading indicator of the future state of the economy

• Marginal Propensity to Consume (MPC)

• Marginal Propensity to Save (MPS)

MPC = ∆ Consumer Spending∆ Disposable Income

MPS = ∆ Saving∆ Disposable Income

MPC + MPS = 1

MPC = 1 - MPS

MPS = 1 - MPC

The Multiplier: An Informal The Multiplier: An Informal IntroductionIntroduction

• Autonomous Change in Aggregate Spending (AAS)

• Multiplier

∆Y = 1_________(1 - MPC) X ∆AAS

Multiplier = ∆Y_____∆AAS

= 1_________(1 - MPC)

The Multiplier: An Informal The Multiplier: An Informal IntroductionIntroduction

Current Disposable Income Current Disposable Income and Consumer Spendingand Consumer Spending

•Relationship between Disposable Income and Consumer Spending

•Consumption Function

•Autonomous Consumer Spending (A)

•Aggregate Consumption Function

• C = A + MPC X DI

Shifts of the Aggregate Shifts of the Aggregate Consumption FunctionConsumption Function

•Changes in Expected Future Disposable Income

•Permanent Income Hypothesis

•Changes in Aggregate Wealth

•Life-cycle Hypothesis

• Planned Investment

Investment SpendingInvestment Spending

The Interest Rate and The Interest Rate and Investment SpendingInvestment Spending

A decrease in the real interest rate will result in

more gross private

investment

r

r’

I

I’

eve

Expected Future Real GDP, Production Expected Future Real GDP, Production Capacity, and Investment SpendingCapacity, and Investment Spending

An increase in either expected future real

GDP or production capacity will result in more

investment at the same

interest rate

r

I

I’