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Unformatted text preview: Chapter 4 Consumption, Saving, and Investment Learning Objectives I. Goals of Chapter 4 A) Examine the factors that underlie economywide demand for goods and services B) Assumes closed economy (for now) C) Focuses on consumption and investment D) Equivalent to studying saving and capital formation E) Examines trade-off of present vs. future F) Goods market equilibrium when desired saving equals desired investment G) Real interest rate plays key role in bringing goods market to equilibrium II. Notes to Fourth Edition Users A) The application on “The response of consumption to stock market crashes and booms” has been deleted, though some of the material has been incorporated into the new application, “Macroeconomic consequences of the boom and bust in stock prices” B) A new application, “A Ricardian tax cut?” discusses the response of consumption and saving to the 2001 tax cut C) The application, “The effect of wars on investment and the real interest rate” has been deleted Teaching Notes I. Consumption and Saving (Sec. 4.1) A) The importance of consumption and saving 1. Desired consumption: consumption amount desired by households 2. Desired national saving: level of national saving when consumption is at its desired level S d = Y – C d – G (4.1) Data Application Recall from Chapter 2 that measured consumption in the national income accounts includes spending on durable consumption goods, like autos and major appliances. But consumption theory requires that consumption be defined to include only the services from durable consumer goods. So empirical researchers must adjust the national income data to arrive at a measure of consumption that matches the theory. For example, they might assume that durable goods provide services proportional to the stock of durables. 52 Abel/Bernanke • Macroeconomics, Fifth Edition B) The consumption and saving decision of an individual 1. A person can consume less than current income (saving is positive) 2. A person can consume more than current income (saving is negative) 3. Trade-off between current consumption and future consumption a. The price of 1 unit of current consumption is 1 + r units of future consumption, where r is the real interest rate b. Consumption-smoothing motive: the desire to have a relatively even pattern of consumption over time C) Effect of changes in current income 1. Increase in current income: both consumption and saving increase (vice versa for decrease in current income) 2. Marginal propensity to consume ( MPC ) = fraction of additional current income consumed in current period; between 0 and 1 3. Aggregate level: When current income ( Y ) rises, C d rises, but not by as much as Y , so S d rises Theoretical Application The classic discussions of consumption are the permanent-income hypothesis of Milton Friedman ( A Theory of the Consumption Function, Princeton: Princeton University Press, 1957) and the life-cycle hypothesis of Franco Modigliani and Richard Brumberg (“Utility Analysis and the...
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This note was uploaded on 04/14/2010 for the course ECONOMICS 2312 taught by Professor William during the Spring '09 term at 東京大学.
- Spring '09