Savings, Consumption, and Fiscal Policy

Savings

Disposable income minus consumption

Consumption schedule

Shows planned consumption at various levels of disposable income

Dissaving

Consuming more than disposable income

Break even income

Level at which households plan to consume their entire incomes

Average propensity to consume (APC)

Percentage of total income that is consumed

Average propensity to save (APS)

Percentage of total income that is saved

Marginal propensity to consume (MPC)

Percentage of any change in income that is consumed

Marginal propensity to save (MPS)

Percentage of any change in income that is saved

Nonincome determinants of consumption and savings

Factors other than income that affect consumption and savings

Wealth

Total value of assets minus liabilities

Wealth effect

Increase in spending and decrease in saving due to a boost in wealth

Borrowing

Increases current consumption beyond disposable income

Reverse wealth effect

Change in wealth due to unexpected changes in asset values

Expectations

Anticipations about future income and economic conditions

Real interest rates

Interest rates adjusted for inflation

Switch to real GDP

Measurement of GDP adjusted for changes in price levels

Changes along schedules

Movements along consumption and savings schedules due to changes in GDP

Simultaneous shifts

Changes in consumption and savings schedules in opposite directions

Taxation

Changes in taxes that shift consumption and savings schedules

Stability

Consumption and savings are generally stable unless affected by major tax changes

Interest rate-investment relationship

Investment is guided by the expected rate of return

Fiscal policy

Deliberate changes in government spending and tax collections

Discretionary policy

Policy at the option of the federal government

Non-discretionary policy

Policy that occurs without congressional action

Expansionary fiscal policy

Designed to increase aggregate demand and raise real GDP

Contractionary fiscal policy

Designed to decrease aggregate demand and lower inflation

Upslope of the aggregate supply curve

Causes demand-pull inflation rather than increased output

Budget surplus

Tax revenues in excess of government spending

Built-in stabilizers

Automatic changes in the budget deficit or surplus during economic cycles

Tax progressivity

Degree to which average tax rate changes with GDP

Progressive tax system

Average tax rate rises with GDP

Proportional tax system

Average tax rate remains constant as GDP rises

Regressive tax system

Average tax rate falls as GDP rises

Cyclically adjusted budget

Compares actual government expenditures with those at full employment GDP

Problems of timing

Recognition, administrative, and operational lags in fiscal policy

Political considerations

Influence of politics on fiscal policy decisions

Political business cycles

Swings in economic activity resulting from election-motivated fiscal policy

Future policy reversals

Permanent vs. temporary tax rate changes and their impact on consumption

Crowding out effect

Increase in interest rates and decrease in investment due to deficit spending

Current thinking on fiscal policy

Monetary policy as the primary stabilization tool, evaluation of long-term impact

Actual investment

Planned investment + Unintended increases in inventory