(21) Chapter 9 Notes.docx - Chapter 9 Notes July 19th 2021...

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Chapter 9 Notes July 19th, 2021 I. 9-1 Consumption A. 9-1a Consumption and Income 1. There is a clear and direct relationship between consumption and disposable income B. 9-1b The Consumption Function 1. Based on their disposable income, households decide how much to consume and how much to save 2. Scarcity prevents you from both spending and saving the same dollar 3. Consumption depends on disposable income 4. Consumption is the dependent variable and disposable income is the independent variable 5. Because consumption depends on income, we say that consumption is a function of income 6. Consumption function is the relationship in the economy between consumption and income, other things constant C. 9-1c Marginal Propensities to Consume and to Save 1. Marginal propensity to consume (MPC) is the fraction of a change in income that is spent on consumption; the change in consumption divided by the change in income that caused it a) Equals the change in consumption divided by the change in income 2. Marginal propensity to save (MPS) is the fraction of a change in income that is saved; the change in saving divided by the change in income that caused it a) Equals the change in saving divided by the change in income 3. Income that is not spend is considered saved 4. Because disposable income is either spent or saved, the marginal propensity to consume plus the marginal propensity to save must sum to 1 5. MPC + MPS = 1 D. 9-1d The MPC Is the Slope of the Consumption Function 1. The marginal propensity to consume is measured graphically by the slope of the consumption function 2. Slope is nothing more than the increase in consumption divided by the increase in income 3. The MPC for any linear, or straight-line, consumption function is constant at all incomes II. 9-2 Non Income Determinants of Consumption A. 9-2a Net Wealth 1. Net wealth is the value of assets minus liabilities
2. An important influence on consumption is each household’s net wealth 3. Consumption and income are flow variables 4. Net wealth is assumed to be constant along a given consumption function 5. A decrease in net wealth would make consumers less inclined to spend and more inclined to save at each income level 6. If net wealth declines, the consumption function shifts down because households now spend less and save more at every income level 7. If net wealth increases, this also increases the desire to spend 8. Because of an increase in net wealth, the consumption function shifts up, reflecting households’ desire to spend more at each income level 9. Research by the Federal Reserve indicates that consumer spending eventually rises or falls between three to five cents for every dollar rise or fall in the value of stock market holdings 10. It is a change in net wealth, not a change in disposable income, that shifts the consumption function 11. A change in disposable income, other things constant, means a movement along a given consumption function, not a shift of that function

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