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Chapter 8 help - Click to edit Master subtitle style...

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4/7/11 Click to edit Master subtitle style The Components of the Aggregate Demand Macroeconomics Spring 2010
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4/7/11 Traditional Consumption Theory What determines consumer spending? Disposable Income Interest Rates The General Price Level Inflation Expectations concerning the future state of the economy Consumer spending is measured over a period of time
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4/7/11 Consumption Theory- Disposable Income Disposable Income Income after taxes and government transfers, is the most important factor affecting consumer spending How does disposable income affect consumer spending? In general as disposable income increases, consumers will have more money to spend, so consumption will increase As disposable income decreases consumers have less to spend, and consumption decreases
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4/7/11 Consumption Theory- Interest rates Changes in the interest rates have an inverse impact on consumer borrowing As interest rates increase the whole consumption function shifts downwards As interest rates decrease the whole consumption function shifts upwards
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4/7/11 Consumption Theory- General Price Level Changes in the general price level affect consumer spending through the wealth effect With a given portfolio of assets, households become more wealthy when prices drop and there is less spending when prices increase A change in prices will, therefore, cause a shift in the whole consumption function Lower prices means more real wealth and more consumer spending; the consumption function shifts up Higher prices means less real wealth and less consumer spending; the whole consumption function shifts down
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4/7/11 Consumption Theory- Expectations Consumers’ expectations are very important in determining spending i.e., expectations about higher future prices could induce consumers to step up spending at the present time i.e., expectations for higher interest rates could induce consumers to buy more cars, household appliances, and other items they normally purchase on credit at present, instead of in the future
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