KW_Macro_Ch_11_Sec_01_Consumer_Spending

KW_Macro_Ch_11_Sec_01_Consumer_Spending - chapter 11 >...

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>> Income and Expenditure Section 1: Consumer Spending chapter 11 Should you splurge on a restaurant meal or save money by eating at home? Should you buy a new car and, if so, how expensive a model? Should you redo that bathroom or live with it for another year? In the real world, individuals and families are constantly confronted with such choices—not just about the consumption mix but about how much to spend in total. These choices, in turn, have a powerful effect on the econo- my: consumer spending normally accounts for two-thirds of total spending on final goods and services. So changes in consumer spending can produce significant shifts of the aggregate demand curve. And as we know from Chapter 10, the position of the aggregate demand curve, along with the position of the short-run aggregate supply curve, determines the economy’s aggregate output and aggregate price level in the short run. But what determines how much consumers spend? In Chapter 10, we learned that consumer spending is affected by wealth and by the interest rate. Here, we’ll focus on two additional significant factors, current disposable income and expected future dis- posable income, in addition to exploring further the effect of wealth.
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2 CHAPTER 11 SECTION 1: CONSUMER SPENDING Current Disposable Income and Consumer Spending The most important factor affecting a family’s consumer spending is its current dis- posable income—income after taxes are paid and government transfers are received. It’s obvious from daily life that people with high disposable incomes on average drive more expensive cars, live in more expensive houses, and spend more on meals and clothing than people with lower disposable incomes. And the relationship between current disposable income and spending is clear in the data. The Bureau of Labor Statistics (BLS) collects annual data on family income and spending. Families are grouped by levels of before-tax income, and after-tax income for each group is also reported. Since the income figures include transfers from the government, what the BLS calls a household’s after-tax income is equivalent to its current disposable income. Figure 11-1 is a scatter diagram illustrating the relationship between household current disposable income and household consumer spending for American house- holds by income group in 2003. For example, point A shows that among the group with an annual income of $40,000 to $49,999, average household current disposable income was $42,842 and average household consumer spending was $39,757 in 2003. It’s clear that households with higher current disposable income had higher consumer spending. It’s very useful to represent the relationship between an individual household’s cur- rent disposable income and its consumer spending with an equation. The consumption function is an equation showing how an individual household’s consumer spending varies with the household’s current disposable income. The simplest version of a con-
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KW_Macro_Ch_11_Sec_01_Consumer_Spending - chapter 11 >...

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