Consumption and National IncomeThe distinction between national income and GDP is relatively minor;for this simple model, we will assume they are equal, and use theterms interchangeablySince:Disposable income = National income -Net taxeswhere“net taxes" are equal to taxes minus transfer payments, we canwrite:National income=GDP=Disposable income+NettaxesIf we assume that net taxes do not change as national incomechanges, we have the result that any change in disposable income isthe same as the change innational income.We will use this in the graph on the next slide16@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 16 Consumption and National Income The distinction between national income and GDP is relatively minor; for this simple model, we will assume they are equal, and use the terms interchangeably. Since: Disposable income = National income − Net taxes where “net taxes” are equal to taxes minus transfer payments, we can write: National income = GDP = Disposable income + Net taxes If we assume that net taxes do not change as national income changes, we have the result that any change in disposable income is the same as the change in national income. We will use this in the graph on the next slide
The Relationship between Consumption and National IncomeNationalChange inChangeinThetableshows therelationshipNetDisposableIncomeNationalDisposableorGDPTaxesConsumptionIncomeIncomeIncomeCbillionsofbillionsof(billionsof(billionsof(billionsof(billionsofbetweenconsumptionanddollars)dollars)dollars)dollars)dollars)dollars)SO$1,000$1000$750national income for an imaginary2.250$2,000$2.0003.0001,0002,000economy,keeping net taxes1,0004,0005,0003,7502,0002,0007,0001,0006,0005,2502,0002,000constant.9.0001,0008,0006,7502,0002,00011,0001,00010,0008,2502,0002,000As national income rises by13,0001,00012,0009.7502,0002,000Real$2,000 billion...consumptionConsumptionspending(bilionsof dollars)consumption rises by $1,500$5.250billion.Change inconsumption=$1,500So the marginal propensity to3.750Changeinconsume for this economy is:nationalincome=$1,500MPC==0.75AC$2,000$1,500 billion$2,000= 0.75MPCAY$2,000 billionFigure 12.3The relationship$5,0007,000Real nationalincomeorrealGDPbetweenconsumption(billions of dollars)andnationalincome17@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 17 The Relationship between Consumption and National Income The table shows the relationship between consumption and national income for an imaginary economy, keeping net taxes constant. As national income rises by $2,000 billion. . consumption rises by $1,500 billion. So the marginal propensity to consume for this economy is: 𝑀𝑃𝐶 = ∆𝐶 ∆𝑌 = $1,500 billion $2,000 billion = 0.75 The relationship between consumption and national income Figure 12.3
Income,Consumption,andSavingBy definition, disposable income not spent is saved. Therefore wecan write:National income = Consumption+ Saving + TaxesY=C+S+TAny changein national incomecanbe decomposed intochanges inthe items on the right hand side:△Y=△C+AS+△TWe assume net taxes do not change, so △T = O; then:△Y=△C+ ASNow divide through by △Y:ASAY△CAYAY△Y@2015Pearson Education,Inc.18
© 2015 Pearson Education, Inc. 18 Income, Consumption, and Saving By definition, disposable income not spent is saved. Therefore we can write: National income = Consumption + Saving + Taxes Y = C + S + T Any change in national income can be decomposed into changes in the items on the right hand side: ∆Y = ∆C + ∆S + ∆T We assume net taxes do not change, so ∆T = 0; then: ∆Y = ∆C + ∆S Now divide through by ∆Y: Y S Y C Y Y + =
Marginal Propensityto SaveAYAS△CAYAYAY△S/△Yistheamountbywhichsavings changes,when(disposable)income changes.This is known as the marginal propensity to saveWecan rewritethe equation aboveas:1 = MPC + MPSThat is, the marginal propensity to consume plus the marginalpropensityto save mustequal 1.This isbecausepart of anyincreasein income is consumed, and the rest is saved19@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 19 Marginal Propensity to Save Y S Y C Y Y + = ∆S/ ∆Y is the amount by which savings changes, when (disposable) income changes. This is known as the marginal propensity to save. We can rewrite the equation above as: 1 = MPC + MPS That is, the marginal propensity to consume plus the marginal propensity to save must equal 1. This is because part of any increase in income is consumed, and the rest is saved
Planned InvestmentInvestment has increased overtime, but unlike consumption, ithas not increased smoothlyand recessions decreaseRealinvestmentinvestment more.(billionsof2009dollars)What affects the level of$3,000investment?2,500Expectations offuture2,000RecessionRecessionsof1990-1991of1980andprofitability1981-1982Recession1,500of2001Interest rate1,000Recessionof2007-2009Taxes500·Cashflow0198819911994197919821985199720002003200620092012We will proceed by examiningFigure 12.4Realinvestmenthow each of these affects thelevel of planned investment.20@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 20 Planned Investment Investment has increased over time, but unlike consumption, it has not increased smoothly, and recessions decrease investment more. What affects the level of investment? • Expectations of future profitability • Interest rate • Taxes • Cash flow We will proceed by examining how each of these affects the level of planned investment. Figure 12.4 Real investment