Chapter 21

Chapter 21: Consumption and Investment

A. Consumption and Saving

B. Investment

Disposable income

Is an important determinant of consumption and saving.

Consumption Function: schedule relating total consumption to total disposable income.

The saving function is the other side or mirror image of the consumption function.

Major features of consumption and saving functions

a. The consumption (or saving) function relates the level of consumption (or saving) to the level of disposable income.

b. The MPC is the amount of extra consumption generated by an extra dollar of disposable income.

The MPS is the extra saving generated by an extra dollar of disposable income.

Graphically, the MPC and the MPS are the slopes of the consumption and saving schedules, respectively.

MPS = 1 = MPC

Individual consumption functions gives us the national consumption function.

it shows total consumption expenditures as a function of disposable income.

The personal saving rate has declined sharply in the last three decades.

Declining saving hurts the economy because personal saving is a major component of national saving and investment.

Gross private domestic investment in housing, plant, software, and equipment

Second major component of spending.

Firms invest to earn profi ts. The major economic forces that determine investment are therefore the revenues produced by investment, the cost of investment, and the state of expectations about the future.

Investment is the most volatile component of aggregate spending.

An important relationship is the investment demand schedule

connects the level of investment spending to the interest rate.

Because the profitability of investment varies inversely with the interest rate, which affects the cost of capital, we can derive a downward-sloping investment demand curve