ECON 252 Module 8: Consumption and Saving

Consumption

household spending on final goods and services

Consumption function

a curve plotting level of consumption associated with each level of income

Marginal propensity to consume (MPC)

fraction of each extra dollar of income that households spend in consumption; MPC= (change in consumption)/(change in income)

Saving

portion of income that you don’t spend in a given period, savings = income - consumption

Dissaving

excess amount you consume above your incoe in a given period, either borrowed money or draining existing savings

Marginal propensity to save (MPS)

MPS = (change in savings)/(change in income)

MPC + MPS

MPC + MPS = 1

Permanent income

your best estimate of your long-term average income; measures the resources available for you to consume, on average, over the course of your lifetime

Permanent income hypothesis

idea that consumption is driven by permanent income rather than current income, macro implication is that economic fluctuations only matter if they impact permanent income 

Insights of permanent income hypothesis

1. Temporary income change leads to small change in consumption

2. Permanent income change leads to large change in consumption

3. Anticipated income change doesn’t change consumption

4. Learning about future income changes leads to consumption change

5. It’s hard to forecast changes in consumption

Credit constraints

limits on how much you can borrow

Determinants of consumption

real interest rates, expectations, taxes, wealth

Real interest rate as determinant

high real interest rate means an increase in saving; high real interest rate reduces current consumption, boosts income for lenders, and decreases borrowers income; empirical evidence suggests high real interest rates lead to decrease in consumption

Taxes as determinant

low taxes translates to higher consumption, high taxes translates to lower consumption

Difference in impacts of multipliers

government spending multiplier > tax multiplier

Factors that influence wealth

stock markets and housing

Savings motives

changing income over the life cycle, changing needs over the life cycle, bequests, precautionary saving

Goods market equilibrium

the point where aggregate demand (AD = C + I) and Y = AD intersect