non income

Factors Influencing Household Consumption and Saving

1. Disposable Income

• Primary factor determining consumption/saving balance.

2. Wealth

• Definition: Value of assets owned.

• Wealth Effect:

  • Increased wealth leads to increased consumption and decreased saving.

  • Decreased wealth leads to decreased consumption and increased saving.

3. Borrowing

• Ability to borrow increases consumption beyond disposable income.

• Short-term consumption increases require future decreases to repay debt.

4. Expectations

• Future prices and income expectations influence spending/saving decisions.

• Concerns about job loss lead to reduced spending and increased saving.

5. Real Interest Rates

• Lower interest rates:

  • Increase consumption due to reduced borrowing costs.

  • Decrease saving due to lower interest earnings.

6. Investment Decisions

• Definition: Firm spending on capital to increase future production.

• Marginal Benefit vs. Marginal Cost:

  • Marginal Benefit: Expected rate of return (additional profit/cost).

  • Marginal Cost: Interest rate for borrowed funds.

• Investment occurs when: Marginal Benefit > Marginal Cost.

Factors Affecting Investment

• Willingness, Interest Rates, Expected Returns, Costs of Capital, Taxes, Excess Capacity, Technological Progress, Economic Expectations.

7. Volatility of Investment Spending

• Highly volatile due to business cycle effects.

• Influenced by actual profits and future expectations.

8. Multiplier Effect

• Increased spending raises real GDP, creating further income and spending cycles.

• Spending Multiplier: Measures how much a nation's GDP changes when its spending changes.

  • Formula: Multiplier = change in real GDP / initial change in spending.

Example Calculation

• If investment spending rises by $2,000,000 and the multiplier is 3, real GDP will increase by $6 million.

• Initial changes in spending can originate in consumer, government, and net export sectors.

9. Marginal Propensity to Consume (MPC)

• Smaller percentage of income consumed leads to a smaller spending multiplier.

• Example: If initial change in spending is $1,000 and MPC is 0.9, spending multiplier is 10 (1/0.1).

• Change in GDP: $10,000.

Lower MPC Example

• If MPC is 0.5, spending multiplier is only 2 (1/0.5), leading to a $2,000 change in GDP from the initial $1,000 change in spending.

10. Complications in Estimation

• Actual estimates are complicated by purchases of imports, taxes, and inflation.

• Economists estimate the actual US spending multiplier is somewhere between 0 and 2.5.