Solved: Do the tests discussed in this section tell you

Macroeconomics 3/18/2016  GDP= C + I + G + (Xg – M ) - C  Consumer Spending - I  Investment Spending  This is NOT Buying Stocks and Bonds  Spending by Businesses (mostly) 1. New tools, equipment, machinery, factories (new capital) 2. Residential Spending – (buying a new home) 3. Changes in Inventory - G  Government Spending  Spending by all levels of government  Excludes transfer payments (purely financial transactions) - Exports (gross Xg) :  Our stuff to others - Imports (M) :  Their stuff to us  Components of GDP - Consumptions - Consumer spending Is the biggest component of total spending 70 – 75% - Spending by households on: 1. Durable goods: 11% - goods that last 1-3 years computers, cars, appliances, cell phones, electronics, instruments, and books 2. Nondurables : 29% - consumables – less than a year : food, alcohol, tobacco, toiletries, medication, fuel products 3. Services : 60% - things you pay to do for you : legal services, personal grooming, home repair services, restaurants, car services  Factors that determine consumption 1. Income - Income is the most important determinant of consumer spending remember circular flow of economic activity - Output = income - Producing stuff generates income for people- consumers, businesses, and governments - Disposable income : income after savings - Disposable income: consumption + saving - Saving is not spending Macroeconomics 3/21/2016  Factors that determine consumption … Continued - Consumer spending 1. Income (continued…)  Disposable income: income after taxes  Disposable income = consumption + saving  More income means more consumption and more saving (less income = less of both) 2. Prices (Walmart and gas prices)  Higher prices reduce consumption  Lower prices increase consumption  You feel “richer” with LOWER prices 3. Wealth Effects: amount of accumulated wealth a person has will (may Should) affect a person’s ability and willingness to spend now  Changes in wealth can change consumer behavior  Wealth: value of financial assets such as stock portfolios and retirement accounts and value of real assets - - your home, car  VERY IMPORTANT: The best measure of wealth is net-worth- value of assets (home, bank, accounts, portfolio, etc.) MINUS liabilities (claims) {mortgages credit card, debt, loans – school Car}  Important accounting tool: balancing sheet Assets Liability (bank claim) and Owners equity 1) $200,000 $200,000 - “0” 2) $300,000 $200,000 3) $200,000 $200,000 - OWE $100,000 Asset example: VALUE OF HOME = $200,000 Liability: VALUE OF MORTGACE LOAN = $200,000 Assume you buy a home for $200,000 and borrow $200,000  Wealth effects using balance sheet 1. Home purchased using mortgage loan - Owner equity = 0 2. Assume home prices rise - Home equity loan or Second Mortgage ($100,000) 3. Home Prices Fall - You owe more than value of home {upside down or under water} 4. Credit Conditions - Availability of credit and interest rates, impact how much households spend- - Easy credit and low rates encourage consumption - Tight credit and high rates discourage consumption 5. Taxes- change disposable income - Increase taxes decrease consumption - Decrease taxes increase consumption 6. Expectations