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Date Created: 10/09/15
Chapter 5 The Household Consumption Sector GDP and Big Numbers 0 Gross Domestic Product GDP is the nation39s expenditure on all the nal goods and services produced in the country during the year Consumption Consumption is the expenditure by individuals on durable goods nondurable goods and services 0 Durable goods ie TV or furniture 0 Nondurable goods ie gas or food 0 John Maynard Keynes noted that consumption is a stable component of income 0 The consumption function states that as income rises consumption rises but not as quickly 0 LE if a country39s disposable income raises by 300 2000 to 2300 its C will rise but by less than 300 If C were 1800 it might raise by 250 to 2050 Disposable lncome billions Consumption billions 1000 14000 2000 22000 3000 3000 4000 3800 5000 46000 Individual Savings 0 Savings is disposable income that is not spent for consumer goods 0 A nation39s saving rate is the percentage of disposable income that is saved 0 During recessions the savings rate tends to raise largely because many people are afraid they may lose theirjobs and hold off on making major purchases 0 Two other factors that in uence our savings rate are interest rates and in ann o If you can earn a high rate of interest on your savings you will be more likely to save than if you could earn just 1 or 2 percent Average Propensity to Consumer and Average Propensity to Save 0 The average propensity to consume APC is the percentage of disposable income spent 0 APC consumptiondisposable income 3000040000 34 075 o The average to save APS is the mirror image of APC The APS is the percentage of disposable income saved o Disposable Income 0 Consumption 0 I 40000 0 I 30000 To calculate APC o 1 Write the formula 0 2 Plug in your numbers 0 3 solve APS savingdisposable income 1000040000 14 025 o Disposable Income 0 Savings 0 20000 0 1500 0 APC consumptiondisposable income 1850020000 185200 3740 0925 0 APS savingsdisposabe income 150020000 15200 340 0075 0 Note APC APS 1 Marginal Propensity to Consume and Marginal Propensity to Save Marginal propensity to consume MPC is the change in consumption divided by the change in income 0 Change in c change in income Year Disposable lncome C 2000 30000 23000 2001 40000 31000 MPC Change in C change in income MPC Change in C change in income 800010000 810 08 o The formula for calculating the marginal propensity to save MPS is MPS change in savings change in income Solution MPS change in savings change in income 200010000 210 02 Graphing the Consumption and Saving Functions 0 There is a vertical line on the left side of every graph called the vertical scale and there is a horizontal line on the bottom side of every graph called the horizontal scale 0 This line has one purpose to equate the horizontal scale with vertical scale that is expenditures with disposable income of 2000 The Consumption Function 0 The consumption function states that as income rises consumption rises but not as quickly Solution Let s say that disposable income raises from 3 trillion to 5 trillion By how much does C rise At a disposable income of 3 trillion C 3 trillion At disposable income of 5 trillion C 4 trillion So when does disposable income rises from 3 trillion to 5 trillion C rises by 1 trillion MPC Change in consumption Change in disposable income 1 trillion 2 trillion 12 05 Now we nd the average propensity to consume when disposable income is 5 trillion Solution APC Consumption disposable income 4 trillion 5 trillion 45 08 The Saving Function Dissaving is when consuming is greater than disposable income 0 The saving function states that as income rises saving rises but not as quickly 0 Disposable income Consumption Saving Autonomous Consumption and Induced Consumption Autonomous consumption is the minimum amount that people will spend on the necessities of life 0 It is called autonomous consumption because it s autonomous or independent of changes in the level of disposable income 0 It39s the level of C when the C line is touching the vertical axis disposable income is 0 Induced consumption is spending induced by changes in the level of income 0 AS disposable income rises induced consumption aso rises when disposable income falls induced consumption falls 0 Consumption Autonomous consumption Induced consumption Solution We know that autonomous consumption is 2 trillion That39s the level of consumption when disposable income is 0 So at disposable income levels of 3 trillion 6 trillion and 9 trillion autonomous consumption remains at 2 trillion Therefore induced consumption must be 1 trillion Consumption Autonomous consumption Induced consumption 3 trillion 2 trillion 1 trillion When disposable income is 6 trillion C 4 trillion Consumption Autonomous consumption Induced consumption 4 trillion 2 trillion 2 trillion When disposable income is 9 trillion C 5 trillion Consumption Autonomous consumption Induced consumption 5 trillion 2 trillion 3 trillion What the Consumer Buys Durable goods are goods that last at least a year or two ie personal computers TVs household appliances cars and furniture Nondurable goods are goods that are expected to last or be used for less than one year ie gas food and children39s clothing Keeping Up with the Joneses Conspicuous consumption is a person39s spending on essentially frivolous goods or services with the sole purpose of showing off one39s wealth He went on to say quotWith the exception of the instinct of selfpreservation the propensity of simulation is probably the strongest and most alert and persistent of the economic motives properquot The Wealth Effect 0 When the value of your home rises or the prices of the stocks you own go up you perceive yourself as being wealthier A Federal Reserve model estimates that for every 1000 that your wealth rises you will spend an additional 3750 375 o This is called the wealth effect The Permanent Income Hypothesis 0 The permanent income hypothesis states that the strongest in uence on consumption is one s estimated Iifetime income 0 From the late 205 to the early 605 current disposable income is usually greater than consumption 0 In retirement age the relationship between consumption and current disposable income is again reserved so consumption is greater than income Chapter 6 The BusinessInvestment Sector Proprietorships Partnerships and Corporations 0 Business rms is a company that produces goods and services for sale to individual consumers other rms or the government Proprietorship is an unincorporated business rm that is owned by just one person 0 A partnership is a business rm owned by two or more people The Proprietorship A typical proprietorship would be a grocery store a barbershop a candy store a restaurant a family farm or a gas station 0 To start a proprietorship a person simpy decides to go into business either opening a new rm or taking over an existing one The partnership 0 A typical division of labor between partners would be production and sales or in the parlance of business inside and outside 0 Both proprietors and partners are liable for all debts incurred by their businesses The Corporation 0 A corporation is a business rm that is a legal person 0 Limited liability means the liability of the owners is limited to the value of the shares in the rm that they own 0 It can sue and be sued Stocks and Bonds Corporation stock is a share in a corporation Stockholders are owners of a corporation Bondholders lend money to a company and are therefore creditors rather than owners 0 Corporate bonds are the debt of the company Capitalization and Control Capitalization consists of the total value of a corporation39s stocks and bonds If the XYZ corporation has 4 billion in preferred stock 6 billion in common stock and 3 billion in bonds a how much is its capitalization b Theoretically how much would it take to control it c Practically speaking it may take only about how much to control it Solutions a 4 billion 6 billion 3 billion 13 billion b 6 billion X 050 3 billion or technically speaking 3 billion 1 c 6 billion X 050 300 million Market Capitalization Market capitalization is found by multiplying a company39s common stock price by the number of outstanding shares If the common stock price of Charley s Candy Company is 215 and it has 10 million shares outstanding how much is its market capitalization Solution 215 X 10000000 2150000000 two billion one hundred fty million dollars 0 A megacap company has a market capitalization in excess of 100 billion Investment 0 Investment is the purchase or construction of any new plant equipment or residential housing or accumulation of inventory Investment De ned PIant includes factories of ce buildings department and other retail stores and shopping maIIs Inventory includes goods on store shelves waiting to be sold cars in a showroom or car lot nished goods in a factory waiting to be shipped and even parts of a product ready to be assembled Business rms do not want to hold more inventory than they need because that means that inventory ties up money and also incurs storage costs 0 Inventory investment is changes in the stocks of nished goods and raw materials that rms keep in reserve to meet orders 0 Human capital is the accumulation of knowledge of knowledge and skills that make a worker productive Gross Investment versus Net Investment 0 Gross domestic product is the sum of consumption gross investment government purchases and net exports Net domestic product is the sum of consumption net investment government purchases and net exports 0 GDP Depreciation NDP 0 Gross investment Depreciation Net investment 0 Gross investment is a company39s total investment in plant equipment and inventory 0 Net investment is gross investment minus depreciation Depreciation is a fall in the price of a nation39s currency relative to foreign currencies 0 GDP C I G Xn where C is consumption I is investment G is government spending and Xn is net exports exports minus imports The Determination of the Level of Investment 0 You wont invest your sales if outlook is bad 0 The capacity utilization rate is the percentage of plant and equipment that is actually being used at the time 0 You wont invest is you have a lot of unused capacity 0 The interest rate is the cost of borrowing money Suppose you want to borrow a 1000 for one year and the bank will charge you 12 interest How much interest with you have to pay if you borrow the 1000 for one year Interest rate Interest paidamount borrowed 012 x1000 120 x o The expected rate of pro t is expected pro ts divided by money investment How much is the expected pro t rate on a 10000 investment if you expect to make a pro t of 1650 Expected rate of pro t Expected pro tsmoney invested 165010000 165 HOUSEHOLD SECTOR CONSUMPTION HOUSEHOLD NET SAVINGS APC Average propensity to consume CY or 1 APS APS Average propensity to save SY or 1 APC MPC Marginal propensity to consume ACAY or 1MPS MPS Marginal propensity to save ASAY or 1MPC AUTONOMOUS CONSUMPTION INDUCED CONSUMPTION BUSINESS ORGINATION STRUCTURES Proprietorships Partnerships Corporations BUSINESS SECTOR Production Financial Sectors FINANCIAL SECTOR Traditional Banking System Commercial Banks Savings and Loans Credit Unions Stock Bond and other Financial Exchange Markets Brokers and Mutual Funds Investment Banks Insurance Companies Financial Rating companies STOCKS BONDS INVESTMENT VS SAVINGS GROSS INVESTMENT NET INVESTMENT PRIVATE SECTOR Household Business Sector