Lec Topic 5 Consumption

ECC1100 Principles of Macroeconomics

Topic 5: Consumption and Saving

  • Overview of consumption and saving patterns.

Key Concepts and Topics

Topics Covered

  • Topic 1: GDP

  • Topic 2: Economic Growth

  • Topic 3: Inflation and Prices

  • Topic 4: Wages, Employment & Labor Market

  • Topic 5: Consumption and Saving

  • Topic 6: Investment

  • Topic 7: International Finance & Exchange Rate

  • Topic 8: The Business Cycle

  • Topic 9: Aggregate Demand & Aggregate Supply

  • Topic 10: Monetary Policy

  • Topic 11: Fiscal Policy

Measuring GDP

  • Expenditure Method

    • Consumption (C): Household spending on goods and services.

    • Investment (I): Spending by firms on final goods, residential, and inventories.

    • Government Expenditure (G): Excludes transfer payments and interest.

    • Net Exports (NX): Exports minus imports.

Learning Objectives

  1. Understand the relationship between consumption, saving, and income.

  2. Apply economic principles to improve consumption decisions.

  3. Predict aggregate consumption behavior.

  4. Analyze how macroeconomic changes affect consumption.

  5. Develop a smart saving plan.

Consumption and Income

Consumption Function

  • Definition: Shows levels of consumption corresponding to income levels.

  • Marginal Propensity to Consume (MPC): The fraction of an additional dollar of income spent on consumption.

Saving

  • Definition: Portion of income not spent on consumption.

    • Formula: Saving = Income - Consumption.

  • Dissaving: Spending beyond income, funded by withdrawing savings or borrowing.

Consumption Decisions

Key Principles

  1. Interdependence Principle: Present choices affect future options.

  2. Marginal Principle: Consumption decisions are broken down incrementally; involve cost-benefit analysis.

  3. Rational Rule for Consumers: Consume more today if immediate consumption benefit exceeds future benefits plus interest.

  4. Consumption Smoothing: The strategy of maintaining consistent consumption over time.

Permanent Income Hypothesis (PIT)

  • Understanding consumption and saving over a lifetime.

    • Income influences consumption based on expected lifetime income rather than current income alone.

Factors Influencing Consumption

  1. Income: Positive correlation between income and consumption.

  2. Real Interest Rates: Impact saving and consumption behaviors.

  3. Expectations: Confidence about future income affects consumption choices.

  4. Taxes: Affect disposable income, thus influencing consumption.

  5. Wealth: Increased wealth often leads to higher consumption.

Consumption Function Shifters

  • Upward Shift: Optimistic future expectations, increased wealth, lower taxes.

  • Downward Shift: Pessimistic future expectations, decreased wealth, higher taxes.

Motivations for Saving

  1. Changing Income: Varies with age and economic lifecycle.

  2. Changing Needs: Life events create different savings needs.

  3. Bequests: Planning for inheritance or wealth transfer.

  4. Precautionary Saving: Saving to protect against unpredicted financial needs.