CONSUMPTION AND INVESTMENT

Christopher N. Sale BSBA - 311

CONSUMPTION - it is the expenditures by consumers on final goods and services. Keynes argued that the most important determinant of consumption is disposable income. Disposable Income -is the amount of income actually take home. This is the share of total income remaining in the hands of households after all the taxes have been paid, transfers have been received and depreciation charges and retained earnings have been subtracted.

Types of Consumption
Durables Non durables Services

None Income Determinants of Consumption

Expectations Wealth Credit Taxes Prices

Consumption Function - is a mathematical relationship indicating the rate of desired consumer spending at various income levels. -it provides a basis for predicting how changes in income (YD) will affect consumer spending (C).

C = a + bYD
Where: C = Current Consumption a = autonomous consumption b = marginal propensity to consume YD = disposable income

Average Propensity to Consume (APC) - is the total consumption in a given period divided by the total disposable income. Marginal Propensity to Consume (MPC) - tell how much consumer expenditure will change in response to changes in disposable income.

Change in Consumption MPC = ---------------------------------------Change in Disposable Income

Marginal Propensity to Save (MPS) - the fraction of each additional (marginal) dollar of disposable income not spent on consumption.

MPS = 1- MPC
Autonomous Consumption - refers to that consumption spending that is independent to current income.

Saving - is the part of disposable income not spent on current consumption; disposable income less consumption. Two Kinds of Consumer Spending 1. Spending not influenced by current income 2. Spending that is determined by current income

Inflation and Consumption Inflation has two effects on consumption: 1. Inflation affects consumer spending because if inflation occurs, people will have money which is worth less, so they can buy less. 2. Increasing consumption may discourage savings and investments. So, people will consume more instead of saving or investing.

SHORT RUN VS. LONG RUN MARGINAL PROPENSITY TO CONSUME

Long-run marginal propensity to consume - it tells how much consumption will increase over the long duration when personal disposable income rises. Short-run marginal propensity to consume -it tells how much consumption will rise over the short run during one business cycle when disposable income rises.

THEORIES ON CONSUMPTION
Permanent-Income Theory - it is named for its distinction between permanent income, which a family expects to be long-lasting and transitory income, which a family expects to disappear shortly. Life-cycle Theory - get its name from it s emphasis on a family looking ahead over its entire lifetime. Forward Looking Theory - embodies the idea that individual consumers are forward looking decision makers. - it assumes that families or individuals base their consumption decisions on their disposable income.

Significance of Consumption
Consumption is the value of goods and services bought by people. Individual buying acts are aggregated over time and space. Consumption is normally the largest GDP component. Many persons judge the economic performance of their country mainly in terms of consumption level and dynamics.

INVESTMENTS

Investments -it is the flow of newly-produced capital goods. It consists of plant and equipment, investment, residential investment and inventory investment. - it is the expenditure on (production of) new plant, equipment and structures (capital) in a given time. - the rate of desired investment depends on: expectations rate of interest technology and innovation

Investment Plays Six (6) Macroeconomic Roles 1. It contributes to current demand of capital goods, thus it increases domestic expenditure. 2. It enlarges the production base, increasing production capacity. 3. It modernizes production processes, improving cost effectiveness. 4. It reduces the labor needs per unit of output, thus potentially producing higher productivity and lower employment. 5. It allows for the production of new and improved products, increasing value added in production. 6. It incorporates international world class innovations.

Investment Function -it explains how the changes in national income induce changes in investment patterns in the national economy. - investment depends positively on the wage rate, negatively on the rental price of capital and positively on output. Properties of Investment Function When the growth of output is high, investment is high. When the real interest rate is high, investment is low. When the price of new capital goods is high, investment is low. When wages are high, investment is high.

RELATIONSHIP BETWEEN GDP, CONSUMPTION, SAVINGS AND INVESTMENT Income = Consumption + Savings
The largest part of total spending is consumption.

C = f(Y)
If income increases, consumption also increases BUT not as quickly as income.

S = f(Y)
If income increases, savings also increases BUT at the higher rate than income.