ECON 1113 1st Edition Lecture 9Outline of Last Lecture I. Recent Developments in the Labor MarketII. Real GDP and the Business CycleOutline of Current Lecture I. Introduction: The Role of Consumer Spending in the Keynesian Short-Run ModelII. Determinations of Consumer SpendingIII. Two Basic MeasuresIV. Two Basic Hypotheses about Consumer SpendingV. An IllustrationCurrent LectureI. The Role of Consumer Spending in the Keynesian Short-Run ModelA. Named after John Maynard Keynes, a British economist of the twentieth centuryB. Based on his book, The General Theory of Money, Employment, and Interest (1936), also known as “The General Theory”1. This book is complex because of Keynes prose2. It is summarized in the Keynesian Model by Sir John HicksC. Keynes believed that the overall of economic activity was determined by how much people plan on spending1. Formalized as Plan Total Expenditure (TE)2. Consumer Spending (C): spending on consumer goods and services3. Investment Spending (I): spending on capital goods and services4. Government Spending (G): government spending units on goods and services5. Export Spending (X): foreign spending on domestic goods and services6. Import Spending (M): spending on foreign goods and services7. TE = C + I + G + (X – M)1. X – M is also referred to as the trade balanceD. National Income Accounts1. Tracks C, I, and G to measure Keynesian ideas2. Created by Harvard’s Simon KuznetII. Determinations of Consumer SpendingA. Disposable (After-Tax) Income1. Yd = Total Income – Taxes or Yd = y – T2. Yd income is a flow variable measured over some time periodThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.B. Credit Conditions1. Reflected by the level of interest ratesC. Consumer Expectations about Future Consumer Goods’ Prices and/or Future Disposable Income LevelsD. Consumer Wealth1. A stock variable measured at a point in time2. Value of assets <minus> value of liabilities = wealthIII. Two Basic MeasuresA. Financial Wealth1. Like stocks, bonds, savings accounts, etc.B. Consumer Durable Goods1. Like cares, refrigerators, washing machines furniture, etc.C. Focus on relationship between consumer spending and disposable income, ceteris paribus1. Called Keynesian Consumption FunctionD. Average Propensity to Consume (APC)1. The fraction of disposable income after tax income spent on consumer goods (C)2. APC = C/Yd3. Example1. Disposable Income = $500/week2. Consumer spending = $400/week3. APC = 400/500 = 0.8 x 100 = 80%4. If someone does not consume part of income, he probably saves itE. Margin Propensity to Consume (MPC)1. Change in consumer spending (C) brought about by change in disposable income (Yd)2. MPC = ∆ C / ∆ YdIV. Two Basic Hypothesis about Consumer SpendingA. As Yd increases, APC decreases1. The rich spend smaller fraction of income on consumer goods and services unlike the poor, who spend most of income on consumer goodsB. 0 < MPC < 11. Fundamental psychological law that people consume only a part of any increase in their disposable incomeV. An IllustrationA. The case of A involves dissaving, which is accomplished by borrowing and/or selling off assets (garage sale effect)B. The case of B is breaking even, in which consumer spending equals disposable incomeYd∆ YdC∆ CAPC (C/ Yd) MPC (S = ∆ Yd−C∆ C / ∆ Yd¿A 0 50000 – 5000 =-5000B 20,00020,00020,00015,00020000/20000 =115000/20000 =0.7520000-20000= 0C100,00080,00080,00060,00080000/100000 =0.860000/80000 =0.75100000-80000=