Aggregate Expenditure: Consumption, Investment, Government Purchases, and Net Exports
We will focus on the relationship between aggregate income Y (remember disposable income, because they don't have any choice about paying taxes. Now remember that in our GDP identity, we had a category called "I" for investment. Disposable income (DI) is one of three measures of income reported in the Two related measures of production are gross domestic product (GDP) and net the difference between personal income and personal tax and nontax payments. taxes. The difference between disposable income and consumption is savings. . income. An expected tax cut that is viewed as permanent could increase current consumption. . In , government purchases accounted for 17% of GDP.
In some cases you might just say, "Well, let's just assume that this is a bulk tax. The other way is you could actually model it a little bit more realistic. You could say, "Hey, taxes really are "a function of aggregate income. I'll write that as a lower case t times aggregate income. In a place like the U. Whatever it might be or aggregate income is what is going to go for taxes.
If you do it this way, and you substitute back to this you could actually get an expression for consumption in terms of aggregate income that takes into consideration the idea that taxes are function of aggregate income.
Consumption function with income dependent taxes (video) | Khan Academy
Just to do that algebraically, we can rewrite this expression up here. Minus the marginal propensity to consume, shows up again. Instead of writing T right over here, I'm going to write lower case t x Y, tax rate times aggregate income. Times the tax rate times aggregate income. I just took this, instead of writing upper case T, I wrote lower case t times aggregate income and they should be the same thing.
But now we've expressed t as a function of aggregate income. Now we can merge both of these, these are something times aggregate income. We can combine those 2 terms. This one and this one write over here. If we factor our a common factor of c1 x Y, we get, let me write it this way. Actually, let me just combine them first so that the algebra doesn't confuse you. Marginal propensity to consume times aggregate income and I'm going to write this one.
Minus the marginal propensity to consume times I'll switch the order here. Well, let me not switch the order, times the tax rate, not just the aggregate total tax value but the actual tax rate times aggregate income.
That's those 2 terms there and then we're just left with the autonomous consumption. So, plus the autonomous consumption. Over here, we have a common factor. We can factor out the c1 and the Y, or essentially the marginal propensity to consume and the aggregate income.
This is just algebraic manipulation right over here. We get aggregate consumption is equal to, let's see, we could write this c1 1 - t Y. You can multiply this out to verify. If you multiply it all out then the 1st term is c1 1 Y is this right over here and c1 -t Y is this term right over here.
The Relationship Between Income & Expenditure
Consumption and income tend to be highly correlated. Income and Consumption Disposable Income - Income actually available for spending is personal income less net taxes. The difference between disposable income and consumption is savings. Consumer spending and disposable income move together over time.
Consumer spending and disposable income increased nearly every year. More recently consumers have in some months increased consumption faster than income resulting in a negative savings rate higher debt accumulations.
The Consumption Function - The relationship between the level of income in an economy and the amount households plan to spend on consumption, other things constant. Households look at their level of disposable income and decide how much to spend. So spending depends on disposable income. The relationship between consumption spending and disposable income is captured by the slope of the consumption function.
Consumption function with income dependent taxes
The influences of other factors that are independent of income are captured by the intercept. Marginal Propensity to Consume and Save Economists use marginal analysis to the relationship between changes in disposable income and changes in consumption. Marginal analysis seeks to answer questions like, "If U.
Because the slope of a line constant everywhere along the line, the MPC for any linear consumption function will be constant at all levels of income. The slope of the saving function equals the MPS. It is also a positive fraction that represents a leakage rate from increases in household income in the circular flow of income.
Because the slope of a line is the same everywhere on that line, the MPS for any linear savings function is constant for all levels of income. The savings function can be derived from the consumption function: Non-income Autonomous Determinants of Consumption Along the consumption function, consumption spending depends on the level of disposable income, other things constant.
What factors are held constant, and how do they affect Consumption? Net Wealth and Consumption Net Wealth - The value of a household's assets minus its liabilities debts owed.
Assets - home, cars, furniture, savings accounts, checking accounts; Liabilities - student loans, car loans, mortgage, credit card balances Household wealth is assumed constant along a consumption function. An increase in net wealth makes a household more likely to spend and less likely to save at each level of disposable income.
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A decrease in net wealth makes a household less likely to spend and more likely to save at each level of disposable income. What happens to net wealth if the value of stock declines? Households that own stock have a decrease in net wealth and are likely to spend less and save more.
The consumption function shifts down. The Price Level Some household wealth is held in dollar-denominated assets bank accounts, cash. When the price level changes, so does the real value of dollar-denominated assets. A falling price level increases the real value of dollar-denominated assets, thereby encouraging greater consumption for goods and services. A higher price level discourages consumption demand as it lowers the real value of the dollar.
The Interest Rate Consumers make inter temporal decisions to consumer or save over their lifetime. Interest is the reward to savers for current saving.
When graphing the consumption function, we assume a given interest rate. If the current interest rate increases, savers will save more, borrow less, and spend less because it increases the opportunity cost of consumption. This, in turn causes the consumption function to shift downward. Lower current interest rates increase consumption and lower savings.