Slide Show #4Slide Show #4AGEC 430

Macroeconomics of Agriculture

Spring 2010

Handout #4Handout #4

GDP = C + I + G + X – MGDP = C + I + G + X – M

where:where:

C = consumption expendituresC = consumption expendituresI = investment expendituresI = investment expendituresG = government expendituresG = government expendituresX = exportsX = exportsM = importsM = imports

Consumption represents 70% of GDP

Consumption represents 70% of GDP

Annual level of personal consumption expenditures. Represents 70 percent of our nation’s GDP.

Annual level of personal consumption expenditures. Represents 70 percent of our nation’s GDP.

Annual percent change in personal consumption expenditures. This graph highlights the recent downturn in C relative to recent recessions.

Annual percent change in personal consumption expenditures. This graph highlights the recent downturn in C relative to recent recessions.

The simple consumption function originally formulated by Keynes back in the late 1930s.

The simple consumption function originally formulated by Keynes back in the late 1930s.

Quarterly level of disposable personal income. The is the Y – T variable in the consumption function on the previous page.

Quarterly level of disposable personal income. The is the Y – T variable in the consumption function on the previous page.

The slope of the consumption function is known as the marginal propensity to consume.

The slope of the consumption function is known as the marginal propensity to consume.

Personal saving rate.

∆C / ∆(Y – T)∆C / ∆(Y – T)

Real wealth effect can be inflationary as we saw in 1990s.What about recent years?

Real wealth effect can be inflationary as we saw in 1990s.What about recent years?

Why is this concept important?Why is this concept important?

A one-time spike in disposable income or “transitory income” will do little to change consumption behavior since it is not expected to continue.

A one-time spike in disposable income or “transitory income” will do little to change consumption behavior since it is not expected to continue.

Age 25 Age 45 Age 65 = T

N – T at age 45

Peak earnings

Lifetime Earnings Cycle

Savings rate low Savings rate rising

We can Graph We can Graph these these

relationshipsrelationships

Planned Consumption FunctionPlanned Consumption Function

The consumption functionin this graph can beexpressed graphically asshown below.

The consumption functionin this graph can beexpressed graphically asshown below.

C = AC + b1(Y - T)C = AC + b1(Y - T)

Autonomous orfixed consumption

Autonomous orfixed consumption

Planned Consumption FunctionPlanned Consumption Function

The slope of theconsumption functionis the marginal propensityto consume (MPC), or C / (Y – T)

The slope of theconsumption functionis the marginal propensityto consume (MPC), or C / (Y – T)

Consumer expenditureswould be $3,600 ifdisposable income wasequal to $3,000.

Consumers would bedis-saving by $600.

Consumer expenditureswould be $3,600 ifdisposable income wasequal to $3,000.

Consumers would bedis-saving by $600.

Planned Consumption FunctionPlanned Consumption Function

C = $1,500 + .70($3,000) = $3,600C = $1,500 + .70($3,000) = $3,600

An increase in disposable income to$4,000 would raiseexpenditures to$4,300.

Dis-saving wouldfall to $300.

An increase in disposable income to$4,000 would raiseexpenditures to$4,300.

Dis-saving wouldfall to $300.

Planned Consumption FunctionPlanned Consumption Function

C = $1,500 + .70($4,000) = $4,300C = $1,500 + .70($4,000) = $4,300

An increase in disposable income to$5,000 would raiseexpenditures to$5,000.

Dis-saving wouldfall to zero.

An increase in disposable income to$5,000 would raiseexpenditures to$5,000.

Dis-saving wouldfall to zero.

Planned Consumption FunctionPlanned Consumption Function

C = $1,500 + .70($5,000) = $5,000C = $1,500 + .70($5,000) = $5,000

A role for fiscalpolicy here:

A cut in the tax rate increases consumption.

An increase in thetax rate decreasesconsumption.

A role for fiscalpolicy here:

A cut in the tax rate increases consumption.

An increase in thetax rate decreasesconsumption.

Planned Consumption FunctionPlanned Consumption Function

A role for fiscalpolicy here:

A cut in the tax rate increases consumption.

An increase in thetax rate decreasesconsumption.

A role for fiscalpolicy here:

A cut in the tax rate increases consumption.

An increase in thetax rate decreasesconsumption.

Planned Consumption FunctionPlanned Consumption Function

Real Wealth EffectReal Wealth Effect

Suppose stock marketprices rose, increasingreal wealth of consumersby $700.

Suppose stock marketprices rose, increasingreal wealth of consumersby $700.

Real Wealth EffectReal Wealth Effect

This would increasethe intercept by $700,

This would increasethe intercept by $700,

Real Wealth EffectReal Wealth Effect

C = $1,500 + $700 + .70($4,000) = $5,000C = $1,500 + $700 + .70($4,000) = $5,000

This shifts the curve upward for given income level, boosts consumer spending to $5,000. This raisesdis-saving to $1,000, raising debt relative to income, and can be inflationary…..

This shifts the curve upward for given income level, boosts consumer spending to $5,000. This raisesdis-saving to $1,000, raising debt relative to income, and can be inflationary…..

Annual percent change in personal consumption expenditures.

Given our discussion thus far, what has caused consumption to decline so sharply?

Given our discussion thus far, what has caused consumption to decline so sharply?