Macroeconomic Theory
Consumption
Attendance
Agenda
1
Consumption data
2
The Keynesian Consumption Function
3
Goods Market Equilibrium
4
Review and to Do
Consumption Data
Consumption in the National Accounts
In the national accounts compiled by the BEA, consumption is called: Personal Consumption Expenditures (PCE)
This is misleading though, as “persons” can refer to nonprofit institutions serving households (NPISHs)
It also includes third party spending on behalf of households (employer health insurance, Medicaid, etc…)
PCE also includes “imputed” purchases like owner’s equivalent rent
PCE types
Services: commodities that cannot be stored or inventoried and that are usually consumed at the place and time of purchase.
Durable goods: Tangible products that last at least 3 years
expensive, easily postponed, often financed on credit
Nondurable goods: Tangible products that last less than 3 years
Consumption in the CE
The BEA conducts a consumer expenditure survey whose main differences include:
Not counting NPISHs
Survey of households, not collected from industry
Not imputing housing
And so on…
It also collects income and demographic information
The Keynesian Consumption Function
Income
YD=Y−T
Where:
Y is real income
T are taxes next of transfers
So:
Yd is disposable income
Consumption
Keynes proposed that on average, consumption was closely related to current income, but would not move 1 for 1 will current income:
C=C(YD)
Often specified as:
C=c0+c1YD where:
c1 is the average propensity to consume out of current income
c0 is the portion of consumption NOT attributable to current income
Goods Market Equilibrium
Defining Total Demand
For a moment, assume all other expenditures in the economy are fixed:
I=ˉI
G=ˉG
NX=¯NX
Total demand in the economy is:
Z=C+ˉI+ˉG+¯NX
Z=c0+c1YD+ˉI+ˉG+¯NX
Z=c0+c1(Y−T)+ˉG+ˉI+¯NX
A Note on Inventories
Z=c0+c1(Y−T)+ˉG+¯NX
For the moment, assume that Z, as written above, excludes changes in inventories (goods in process or ready for sale but not sold)
This means that when:
Y=Z
Inventory accumulation/decumulation is zero
Equilibrium and Inventories
We assume that producers make predictions about demand and have a target inventory
These two considerations help them determine the amount to produce
However, they could be wrong, in which case inventories will either be drawn down or pile up
Equilibrium and Inventories
If inventories pile up because Y>Z, we can assume producers will increase production next period
If inventories are drawn down because Y<Z, we can assume producers will decrease production next period
If inventories are at target because Y=Z producers will not change production (equilibrium)
Equilibrium Algebraically
Deriving Equilibrium
Y=Z
Y=cc+c1(Y−T)+ˉI+ˉG+¯NX
Y−c1Y=c0−c1T+ˉI+¯NX
Y=11−c1(c0−c1T+ˉI+ˉG+¯NX)
The Mulitplier and Autonomous Spending
Y=11−c1(c0−c1T+ˉI+ˉG+¯NX)
We call (c0−c1T+ˉI+ˉG+¯NX) autonomous spending
We call 11−c1 the multiplier
The Multiplier
The multiplier implies that a change in autonomous spending will cause an even larger change in equilibrium GDP
Spending creates income which then induces further spending
This priniciple is at the core of a lot of macroeconomic policy making
You can think of autonomous spending as a splash, and the multiplier as ripples
Equilibrium Graphically
Adjustment to Equilibrium
Adjustment
The adjustment of output over time is called the dynamics of adjustment.
How long the adjustment takes depends on how and when firms revise their production schedule.
In other words, the full multiplier effect won’t happen immediately.
Effects of a change in spending over time
- Period 1
ΔC→ΔY
- Period 2
c1(ΔY)
- Period 3
c1(c1ΔY)
- Period 4
c1(c1(c1(ΔY)))
Summing the series
ΔY+c1(ΔY)+c21(ΔY)+c31(ΔY)+…+cn1(ΔY) Extracting Y ΔY(1+c1+c21+…+cn1)
As the series approaches its limit:
ΔY(11−c1)
Review and To-Do
Review
1
Consumption data
2
The Keynesian Consumption Function
3
Goods Market Equilibrium
To-Do
Read pp.250 - 259 in “Consumption and Investment”
Read “The Mysterious Disappearance of James Duesenberry”
We will do some practice consumption problems in-class next week with a homework due on Wednesday
