ConsumptionConsumption tends to followa relatively smooth, upwardtrend; its growth declinesduring periods of recession.Realconsumption(billions of 2009 dollars)What affects the level$11,000of consumption?10.000Recession.Currentdisposableincome9,000of2001Recession8,000:Household wealthof2007-20097,000RecessionsExpectedfutureincome6.000of1980and198119825,000ThepricelevelRecessionof1990-19914,000.The interest rate3,000199519791983198719911999200320072011We will proceed by examiningFigure 12.1Realconsumptionhoweachofthese affectsthelevel of consumption.@2015PearsonEducation,Inc.11
© 2015 Pearson Education, Inc. 11 Consumption Consumption tends to follow a relatively smooth, upward trend; its growth declines during periods of recession. What affects the level of consumption? • Current disposable income • Household wealth • Expected future income • The price level • The interest rate We will proceed by examining how each of these affects the level of consumption. Figure 12.1 Real consumption
DeterminantsofConsumptionCurrent disposable incomeConsumer expenditure is largely determined by how much moneyconsumers receive ina given year.We measure this bypersonalincome, minus personal income taxes, plus government transferpayments such as Social Security.Income expands most years; hence so does consumption.HouseholdwealthA household's wealth can be thought of as its assets (like homes,stocks andbonds,and bank accounts)minus its liabilities(mortgages, student loans, etc.).Households withgreater wealth will spend more on consumption,even with similar incomes.Recent studies estimate that an extra$1,000inwealthwillresultin$40-$50 inextraannual consumptionspending, holding constant the effect of income.122015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 12 Determinants of Consumption Current disposable income Consumer expenditure is largely determined by how much money consumers receive in a given year. We measure this by personal income, minus personal income taxes, plus government transfer payments such as Social Security. Income expands most years; hence so does consumption. Household wealth A household’s wealth can be thought of as its assets (like homes, stocks and bonds, and bank accounts) minus its liabilities (mortgages, student loans, etc.). Households with greater wealth will spend more on consumption, even with similar incomes. Recent studies estimate that an extra $1,000 in wealth will result in $40-$50 in extra annual consumption spending, holding constant the effect of income
MoreDeterminantsof ConsumptionExpectedfutureincomeMost peoplepreferto keep theirconsumption fairly stable from yearto year, a process known as consumption-smoothing.Example: Salespeople workingon commission might have highincomesinsomeyears,andlow incomesinothers.Inordertopredicttheirconsumption,we would need to know what theybelieved theirincome would be inthe futureThepricelevelAs prices rise, household wealth falls. If you have $100,000 in thebank, that will buy fewer products at higher prices. Consequently,higherprices result in lower consumptionspendingTheinterest rateHigherrealinterestrates encouragesavingratherthanspending,sothey result in lowerspending,especially on durable goods.132015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 13 More Determinants of Consumption Expected future income Most people prefer to keep their consumption fairly stable from year to year, a process known as consumption-smoothing. Example: Salespeople working on commission might have high incomes in some years, and low incomes in others. In order to predict their consumption, we would need to know what they believed their income would be in the future. The price level As prices rise, household wealth falls. If you have $100,000 in the bank, that will buy fewer products at higher prices. Consequently, higher prices result in lower consumption spending. The interest rate Higher real interest rates encourage saving rather than spending; so they result in lower spending, especially on durable goods
The Consumption FunctionRealRealconsumptionconsumptionspendingspending(billionsof(billionsof2009 dollars)2009dollars)$12,000$12,0002012201210,00010,0008.0008.0006,0006,000199019904,0004,0002,0002,0001960196006,0008.00010.00012.0000$2,0004,000$2.0004,0006.0008.00010.00012.000Real disposable incomeRealdisposable income(billions of2009dollars)(billionsof2009dollars)(a)Consumptionandincome,1960-2012(b)TheconsumptionfunctionHowstrongistherelationshipbetweenFigure 12.2The relationshipbetweenconsumptionincome and consumption?andincome:1960-2012As the graphs demonstrate, the answer is “very strong". A straightline (called the consumptionfunction)describes this relationshipvery well, suggesting that households spend a consistent fraction ofeach extra dollar of real disposable incomeon consumption.14@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 14 The Consumption Function How strong is the relationship between income and consumption? As the graphs demonstrate, the answer is “very strong”. A straight line (called the consumption function) describes this relationship very well, suggesting that households spend a consistent fraction of each extra dollar of real disposable income on consumption. The relationship between consumption and income: 1960-2012 Figure 12.2
Marginal Propensityto ConsumeThe graphs showedthat consumers seemtohavea relativelyconstant marginal propensity to consume: the amount by whichconsumption spending changes when disposable income changesThis marginal propensity to consume (MPC) is the slope of theconsumptionfunction,therelationship between consumptionspending and disposable income.We can therefore estimate the MPC by estimating the slope of theproduction function:ACChange in consumptionMPC=?Change in disposable income△YDFor 2002-2003, we find:ACS$259 billion0.97AYDS$266 billionSo ifincomes rose $1o billion,we estimate consumption would riseby $10 billion x 0.97 = $9.7 billion.152015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 15 Marginal Propensity to Consume The graphs showed that consumers seem to have a relatively constant marginal propensity to consume: the amount by which consumption spending changes when disposable income changes. This marginal propensity to consume (MPC) is the slope of the consumption function, the relationship between consumption spending and disposable income. We can therefore estimate the MPC by estimating the slope of the production function: 𝑀𝑃𝐶 = Change in consumption Change in disposable income = ∆𝐶 ∆𝑌𝐷 For 2002-2003, we find: ∆𝐶 ∆𝑌𝐷 = $259 billion $266 billion = 0.97 So if incomes rose $10 billion, we estimate consumption would rise by $10 billion x 0.97 = $9.7 billion