05%20Consumption,%20Saving,%20and%20Investment,%20Part%201

05%20Consumption,%20Saving,%20and%20Investment,%20Part%201...

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1 5-1 Consumption, Saving, and Investment, Part 1 5-2 Agenda • Consumption and Saving • Determinants of National Saving • Investment 5-3 Consumption and Saving • Consumption and saving decisions : ¾ Desired consumption is the consumption amount desired by households ¾ Desired national saving is the level of national saving when consumption is at its desired level: S d = Y – C d –G 5-4 Consumption and Saving • Consumption and saving decisions: ¾ A person can consume less than current income, i.e., saving is positive. ¾ A person can consume more than current income, i.e., saving is negative.
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2 5-5 Consumption and Saving • Consumption and saving decisions: ¾ There is a trade-off between current and future consumption: • The price of 1 unit of current consumption is 1 + r units of future consumption, where r is the real interest rate. Consumption-smoothing motive : the desire to have a relatively even pattern of consumption over time. 5-6 Consumption and Saving • Effect of changes in current income : ¾ Increases in current income increase both consumption and saving. • Because the marginal propensity to consume —the fraction of additional income consumed—is less than 1. ¾ When current income ( Y ) rises, C d rises, but not by as much as Y , so S d also rises. 5-7 Consumption and Saving • Effect of changes in expected future income : ¾ Higher expected future income raises current consumption even at the same current income level, so current saving declines. 5-8 Consumption and Saving • Effect of changes in wealth : ¾ Increase in wealth raises current consumption even at the same current income level, so current saving declines.
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3 5-9 Consumption and Saving • Effect of changes in the real interest rate : ¾ A higher real interest rate has 2 effects. The Substitution effect on saving is positive because a higher rate of return is a greater reward for saving. The Income effect on saving is mixed: – It is negative for a net saver because it takes less saving to achieve a given amount in the future (target saving). – It is positive for a net borrower because a higher real interest rate represents a loss of wealth. 5-10 Consumption and Saving • Effect of changes in the real interest rate : ¾ Taxes and the real return to saving. • The expected after-tax real interest rate is given by: r a-t =(1– t ) i π e 5-11 Consumption and Saving • Effect of changes in fiscal policy : ¾ Changes in fiscal policy affects desired consumption through changes in both current and expected future income. ¾
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05%20Consumption,%20Saving,%20and%20Investment,%20Part%201...

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