ECON 205 2nd Edition Lecture 7 Outline of Last Lecture I Answer key given to previous test II Consumption function III Marginal propensity IV Federal policy and taxation V Outline of Current Lecture I Savings the savings function and investment II Consumption and the consumption function III Marginal propensity IV Economic cycles Current Lecture I Savings the savings function and investment Savings could be equal to investment But in reality it could be different it could be greater or less than it as well However the relationship between savings and investment is significant Not only domestic savings going into investment Worldwide integration makes financial resources shift between nations Many countries could have much more investment than domestic savings like China The savings function shows the relationship between the level of saving and disposable income The break even point is where the consumption function intersects the 45 degree line of level of disposable income it is the point in which households break even Investment happens for many reasons including revenues cost expectations and the role of interest rate on investment which shifts the investment function Autonomous investments are the marginal efficiency of capital is the expectation of profit It influences investors to invest It is autonomous from current economic conditions II Consumption and the consumption function Consumption is made up of durable goods automobiles furniture nondurable goods food clothing energy and services transportation healthcare and recreation It makes up approximately 70 of a country like the US s GDP Services are largest category in modern economies Consumption priorities from greatest to least are food housing transportation medical and then savings The consumption function shows the level of consumption expenditures and the level of disposable personal income Ergo the consumption function is the relation between consumption and income It is relatively stable Disposable income is equal to personal income minus personal taxes Furthermore disposable income minus consumption and interest equals personal savings Disposable income is aftertaxes income and is spent on either consumption or savings III Marginal propensity MPC the marginal propensity to consume It is the extra amount that people consume when they receive an extra dollar of disposable income The slope of the consumption function is the marginal propensity to consume Marginal propensity to consume and the marginal propensity to save equals 1 The determinants of consumption are disposable income permanent income the life cycle method of consumption wealth and expectation of future income Laffer curve the relationship between taxes and revenue At zero tax you get zero revenue while at 100 tax you also get zero revenue At optimal tax you get the maximum of revenue for taxes IV Economic cycles GDP growth in market economics is not smooth it occurs in cycles The cycles have four phases expansion of the economy peak economic conditions contraction of the economy and trough or revival The causes of cycles are complex but some of the more common are employment and unemployment rates profits real income inflation interest rates and pessimism vs irrational exuberance The duration of a business cycle is between two to ten years Different theories of why the business cycle occurs are exogenous vs internal factors financial crises panics of early capitalism 19th century investment in railroad canals land resources etc hyperinflation economic bubbles 2007 2008 Dot Com companies over investment coupled with under consumption political factors and inventions innovations and discovery