15 CONSUMPTION FUNCTION

15 CONSUMPTION FUNCTION - SECTION 15: THE CONSUMPTION...

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SECTION 15: THE CONSUMPTION FUNCTION
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THE CONSUMPTION FUNCTION Three things to do with income (Y) 1. Spend it (Consumption = C) 2. Save it (Saving = S) 3. Pay taxes (Taxes = T) Y = C + S + T
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DISPOSABLE INCOME: Y d = Income available after paying taxes Y d = Y - T = C + S
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There are only two things to do with disposable income 1. Spend it (consumption = C) 2. Save it (saving = S) Y d = C + S
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CONSUMPTION FUNCTION Expresses consumption spending as a function of disposable income Holding all other variables constant
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Other variables also influence the level of consumption Wealth Expected future income Expected inflation rates Level of interest rates
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WEALTH VERSUS INCOME WEALTH (OR NET WORTH): Value of what you own minus what you owe
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INCOME: Amount you earn in a given time period
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Wealth is what you have saved over your lifetime An old person could be extremely wealthy and have almost no income
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CONSUMPTION FUNCTION FOR A HOUSEHOLD Consumption spending increases as income increases C = f(Y) Or C = f(Yd)
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The relationship between consumption and income is close to linear Slope of function decreases as income increases.
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CONSUMPTION FUNCTION FOR THE U.S. ECONOMY Consumption spending (C) increases as GDP increases. C = f(GDP) = f(Y) Or C = f(Y d ) where aggregate income (Y) = GDP
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Historically, the relationship has been almost exactly linear. Frequently, we express C as a function of Y, rather than Y
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15 CONSUMPTION FUNCTION - SECTION 15: THE CONSUMPTION...

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