ECON 0110 1st Edition Lecture 20MARGINAL PROPENSITY TO CONSUME (MPC)VS. THE AVERAGE PROPENSITY TO CONSUME (APC)APC = Total consumption spending/ Total incomeAPC = C/ YdMPC = C / YdThe APC tells us the proportion of our entire disposable income that has been spent onconsumption.The MPC tells us the proportion of any increase in our disposable income that will be spent onconsumptionThese 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.IF THE CONSUMPTION FUNCTION IS A STRAIGHT LINE, THE APC DECREASES AS Yd INCREASES.Example: C = 6 + .7 YdC Y APC13 10 1.320 20 1.027 30 0.934 40 .85DRAW A 45 DEGREE LINE THROUGH THE ORIGIN ON THE GRAPH WITH THE CONSUMPTIONFUNCTIONThis 45 degree line is the locus of all points such that the value on the vertical axis equals thevalue on the horizontal axis.The line representing the consumption function shows the amount of desired consumptionspending associated with any level of disposable income.Suppose a point on the consumption function lies ABOVE the 45 degree line.Then C > Yd.This means that consumption exceeds income.Suppose C exceeds disposable incomeThis tends to occur when income is low.These families dissave.Suppose a point on the consumption function lies BELOW the 45 degree line.Then C < Yd.Thus, income exceeds consumption.This tends to occur when income is high.Suppose a point on the consumption function lies ON the 45 degree line.Then C = YdThis means that income equals consumption.These families just BREAK EVEN.IF THE CONSUMPTION FUNCTION IS A STRAIGHT LINE, THE MPC IS CONSTANTC = 6 + .7 YdC Y APC6 0 13 10 1.3 C/Y = 7/10 = .720 20 1.0 C/Y = 7/10 = .727 30 0.9 C/Y = 7/10 = .734 40 .85 C/Y = 7/10 = .7AUTONOMOUS INVESTMENTInvestment spending that does not depend on the level of GDP.INDUCED INVESTMENT= Investment spending that increases or decreases as GDP increases of decreasesTHREE CATEGORIES OF INVESTMENT SPENDING1. PLANT AND EQUIPMENT SPENDINGInfluenced by state of the economy and by level of interest rates2. NEW RESIDENTIAL CONSTRUCTIONInfluenced by level of interest rates3. CHANGE IN INVENTORIESThe desired change in inventories does not necessarily equal the actual change ininventories.The level of inventory cannot be completely determined by a business firmConsumers may buy more or less than the firm expected.DESIRED INVESTMENT SPENDING= the amount businesses wish to spend on new plant and equipment+ the amount contractors wish to spend on new residential construction+ the amount that businesses wish to spend to add to their stock of inventoryACTUAL INVESTMENT SPENDINGDesired investment will not necessarily equal actual investment spending.Businesses cannot necessarily achieve their desired change in inventories.If actual investment > desired investment, then businesses will REDUCE their spending to makeactual investment equal to desired investment.This occurs when actual inventories > desired inventoriesIf desired investment > actual investment, then businesses will INCREASE their spending tomake actual investment equal to desired investment.This occurs when desired inventories > actual inventoriesPLOT INVESTMENT SPENDING VERSUS GDPPlot desired investment spending on the vertical axis.Plot the level of GDP on the horizontal axis.If all desired investment spending is autonomous, the investment function will be horizontaland have a slope of zero.CHANGES IN AUTONOMOUS INVESTMENTFactors that increase the level of autonomous investment spendingIncreases in Expected ProfitsDecreases in interest ratesTechnological change and new productsIf autonomous investment spending increases, the investment function shifts upward, parallelto itself.INDUCED INVESTMENT SPENDINGInvestment spending that is induced by increases in the level of GDPOther things being equal, an increase in GDP will lead to an increase in investment spending.This is called induced investment.Suppose we plot the desired amount of investment spending on the vertical axis and the levelof GDP on the horizontal axis.If there is induced investment spending, the investment function will have an upward slope PLANNED (OR DESIRED) INVESTMENTThe plant and equipment spending, residential construction spending, and inventoryspending that firms DESIRE to undertakeACTUAL INVESTMENTThe actual amount of investment spending that ACTUALLY takes placeActual investment includes unplanned changes in inventory spendingACTUAL INVESTMENT CAN BE GREATER THAN PLANNED INVESTMENTSuppose a car manufacturer thinks consumers will purchase 90 cars and the company wants toincrease its inventory of cars on the showroom floor by 10 cars. Thus, the company produces100 cars.If consumers do not purchase as much as the producer expected them to purchase, theproducer’s inventory will increase above its desired level and will not equal desired inventory.That is, there will be an unplanned increase in inventory.In the example, suppose the company produced 100 cars and that consumers purchased 85 cars(rather than the 90 cars that the company expected). The company wanted to add 10 cars to itsinventory, but its actual inventory increases by 15 cars.That is, actual investment spending will exceed desired (or planned) investment spending.ACTUAL INVESTMENT CAN BE LESS THAN PLANNED INVESTMENTIf consumers purchase more than a producer expected them to purchase, the producer’sinventory will decrease and will not equal desired inventory.That is, there will be an unplanned decrease in inventory.That is, total investment spending will be less than desired (or planned) investment