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Chapter3_302

# Chapter3_302 - CHAPTER 3 I Consumption and Saving Functions...

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CHAPTER 3 I. Consumption and Saving Functions A. Short-run cons. function: relationship between Y d and cons. for the current year (consumption over the business cycle). B. Total consumption (C) includes autonomous and induced consumption 1. Induced consumption: a. Assumes that cons. increases with disposable income (Y d ) (Note: Y d = national income (Y) - net taxes (T) ) b. Marginal propensity to consume (MPC) = change in cons. for a change in Y d c. MPC = c = Δ C/ Δ Y d slope of cons. function (i.e., c = rise/run) d. e.g., if MPC = .75 $.75 is consumed for each additional$1.00 of income 2. Autonomous consumption (a) : level of cons. that is independent from income a. When Y d = 0 , short-run consumption 0 (you must consume to live). b. Consumers draw on accumulated wealth (savings and other assets) to maintain a minimum level of cons. in the short-run c. Constant term in the cons. function 3. Assume a linear consumption function: a. C = a + c Y d ; a \$ 0 0 < c < 1 b. C = 500 + .75 Y d c. Graph 3-1. C. Saving Function 1. Since households save the part of Y d that is not consumed, the consumption function implies the saving function 2. Initial dissaving (-a) : reflects decumulation of assets that results from auton. cons. (intercept of saving function) 3. Marginal propensity to save (MPS) : change in saving (S) per unit change in Y d (induced sav.) a. By definition: Y d = C + S MPC + MPS = 1 or MPS = 1 - c = s

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2 b. MPS = s = Δ S/ Δ Y d slope of saving function. c. MPS induced saving as Y d 4. By Definition: Y d = C + S a. S = Y d - C = Y d - (a + c Y d ) = -a + (1 - c) Y d = -a + s Y d saving function b. Assume: s = -500 + .25 Y d c. Graph 3-2 d. Dissaving = induced saving - auton. cons. = s Y d - a e. Dissaving occurs until induced saving flow offsets auton. cons. (at Y d =2000 , .25 Y d = 500 = a ) f. Saving occurs once saving flow from income > auton. cons. (at Y d > 2000 ) III. Equilibrium real income and output (Y e ) A. Assumptions 1. Price level is constant % Δ GDP R is the same as % Δ GDP N 2. Planned Investment (I p ) is not a function of interest rates (i.e., constant value) influence I p and Y e B. Planned consumption expenditure (C p ) is a function of Y d 1. Disposable income with taxes: Y d = Y - T (where T = net tax revenues) 2. Tax assumptions: a. Autonomous (or lump sum) taxes b. T a is independent from Y T a must be paid regardless of income level 3. Consumption function with autonomous taxes a. C = a + cY d C = a + c(Y - T _) C = a - c T a + cY b. net autonomous cons. = a - c T a auton. cons. reduced due presence of
3 auton. tax c. total autonomous consumption by c T a Parallel downward shift in cons. function d. Assume: T a = 400 and c = .75 C = 500 - .75(400) + .75 Y C = 500 - 300 +.75 Y C = 200 + .75 Y C. Planned investment (I p ) : autonomous planned expend. on capital investment and inventory 1. Autonomous assumption

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Chapter3_302 - CHAPTER 3 I Consumption and Saving Functions...

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