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.