CHAPTER 9: BASIC MACROECONOMIC RELATIONSHIPS

• The Consumption Schedule

It reflects the direct consumption – disposable income relationship and it is consistent with many household budget studies.

• The Saving Schedule

Saving equals disposable income less consumption.

•  Average and Marginal Propensities

• APC and APS

Average Propensity to Consume – the fraction, or percentage, of total income that is consumed.
Average Propensity to Save – the fraction of total income that is saved.

• MPC and MPS

Marginal Propensity to Consume – The proportion or fraction, of any change in income is consumed.
Marginal Propensity to Save – The fraction of any change in income saved.

• Nonincome Determinants of Consumption and Saving

• Wealth
• Expectations
• Real Interest Rates
• Household Debt
• Taxation

• Terminology, Shifts and Stability

• Schedule Shifts – changes in wealth, expectations, interest rates and household debt will shift the consumption schedule and the saving schedule in the opposite direction.
• Stability – Although changes in nonincome determinants can shift the consumption and saving schedules, usually theses schedules are relatively stable.

THE INTEREST-RATE-INVESTMENT RELATIONSHIP

• Expected Rate of Return – The increase in profit a firm anticipates it will obtain by purchasing capital; expressed as a percentage of the total cost of the investment activity.

• The Real Interest Rate –The interest rate expressed in dollars of constant value and equal to the nominal interest rate less the expected rate of inflation.

• Investment Demand Curve

The economy’s investment demand curve is found by cumulating investment projects, arraying them in descending order according to their expected rates of return, graphing the result and applying the rule that investment should be undertaken up to the point at which the real interest rate, i, equals the expected rate of return, r.

• Shifts of the Investment Demand Curve

• Acquisition, maintenance and operating costs of capital goods
• Business taxes
• Technology
• The stocks of capital goods on hand
• Expectations

• Instability of Investment

• Availability of capital goods
• Irregular occurrence of major innovations
• Profit volatility
• Variability of expectations

THE MULTIPLIER EFFECT
An increase in investment spending ripples through the economy, ultimately creating a magnified increase in real GDP. It is the ultimate change in GDP divided by the initiating change in investment or some other component of spending. It is equal to the reciprocal of the marginal propensity to save.