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cons-invest - Consumption and Investment Consumption...

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Consumption and Investment Consumption and Investment Graduate Macroeconomics I ECON 309 -- Cunningham
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2 Keynesian Theory Keynesian Theory Recall that Keynes argues that C= C 0 + cY, with C 0 > 0 and the average propensity to consume (APC = C/Y) is greater than the marginal propensity to consume (MPC = c): C/Y = (C 0 + cY)/Y > c, or (1) APC > MPC (2) Moreover, the APC should not be a constant if C 0 is not zero. If C 0 = 0, then the consumption function reduces to the absolute income hypothesis —consumption is proportionate to income—which is not consistent with Keynes.
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3 Empirical Verification? Empirical Verification? Keynes’ followers estimated the consumption function for the U.S. using the data from 1929-1941: C = 26.5 + 0.75Yd C 0 =26.5 billion > 0 APC > MPC Increases in consumer spending seemed to be less than increases in disposable income, supporting MPC < 1.
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4 Kuznets’ Consumption Data Kuznets’ Consumption Data Kuznets, Simon. Uses of National Income in Peace and War , Occasional Paper 6. NY: NBER, 1942. Time series estimates of consumption and national income Overlapping decades 1879-1938, 5 year steps Each estimate is a decade average Kuznets, Simon. National Product Since 1869 . NY: NBER, 1946. Extended data backward to 1869.
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5 Kuznets’ Study (1) Kuznets’ Study (1) Assumptions: Personal taxes and transfer payments are small (in this period) Therefore, it is reasonable to use total income (GNP) as a proxy for disposable income. If a relationship between consumption and disposable income exists, there should also be a relationship between consumption and GNP.
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6 Kuznets’ Study (2) Kuznets’ Study (2) (1946 study) Between 1869-1938, real income expanded to seven (7) times its 1869 level ($9.3 billion to $69 billion) But the average propensity to consume ranged between 0.838 and 0.898. That is, APC did not vary significantly in the face of vastly expanding income. Results: Problem!
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7 Kuznets’ Study (3) Kuznets’ Study (3) Years Y C C/Y 1869-78 9.3 8.1 0.87 1874-83 13.6 11.6 0.85 1879-88 17.9 15.3 0.85 1884-93 21.0 17.7 0.84 1889-98 24.2 20.2 0.83 1894-1903 29.8 25.4 0.85 1899-1908 37.3 32.3 0.87 1904-13 45.0 39.1 0.87 1909-18 50.6 44.0 0.87 1914-23 57.3 50.7 0.88 1919-28 69.0 62.0 0.90 1924-33 73.3 68.9 0.94 1929-38 72.0 71.0 0.99
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8 Second Failure Second Failure Predictions of post-WWII period are grossly wrong Keynesian Theory argues that the average propensity to save (APS) rises with income (S = S 0 + sY). Higher post-war incomes should imply excess saving. Excess saving is more than can be absorbed by investment. Therefore the excess saving will result over-investment or hoarding, and therefore in unemployment. Will we go straight back to the Depression? Comparison of the forecasts with the actual results suggest that: consumption was “under”-predicted saving was “over”-predicted IMPLICATION : major determinants in the behavioral equations must be missing!
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9
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10 Reconciliation with Keynes’ Theory? (1) Reconciliation with Keynes’ Theory? (1) t = 1923 t = 1924 t = 1925 Kuznets Y t * C t * Arthur Smithies, Econometrica, 1954.
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