University:
California State University, Northridge
Course:
ECON 500 | Survey of Economics
Academic year:

2024
Views:

143

Pages:

16
Author:

Gabrielle Mcknight

Aggregate Demand and the Powerful Consumer Part 2 Outline ● Factors that shift the consumption f(x) ● Extreme variability of I ● Determinants of net exports Copyright© 2006 Southwestern/Thomson Learning All rights reserved. Factors That Shift the Consumption Function ● Consumer expenditures are influenced by factors other than DI, so we must distinguish between a movement along vs a shift in the C f(x). ● ∆ DI ⇒ movement along a C f(x) ● ∆ any other variable that affects C ⇒ shift in the entire C f(x) FIGURE 6. Shifts of the Consumption Function Real Consumer Spending Movements along consumption function C1 C0 C2 A Shifts of consumption function Real Disposable Income Factors That Shift the Consumption Function ● Other determinants of consumer spending: 1. Wealth ● Source of purchasing power which is different from income. ● If 2 people earn $45K and 1 has a bank account with $100K, who will spend more this year? ● A stock market or housing boom may ↑C while a bust in either may ↓C. Factors That Shift the Consumption Function 2. Price Level ● Much consumer wealth is held in forms where values are fixed in $ terms. ♦ ♦ E.g., gov or corporate bonds, and bank accounts –all assets with fixed face values in $ terms Purchasing power of any money fixed asset falls when P level↑ because these assets now buy less. ■ If ↑P level by 10% then a $1,000 gov bond buys $100 less than it could when prices were lower. Factors That Shift the Consumption Function 2. Price Level (cont.) ● ↑P level → ↓C by eroding the purchasing power of consumer wealth. ♦ U.S. consumers hold $8T in money fixed assets, so a ↑1% P level → ↓purchasing power by $80B. ● ↑P level → ↓real wealth → ↓spending at any level of real income. ● Note: ∆P level works through real wealth and not real income. Any ∆ real income is a movement along a fixed C f(x). Vs any ∆ real wealth shifts the C f(x). Factors That Shift the Consumption Function 3. Real interest rate ● ↑interest rates reward those who save, so you might expect that ↑i → ↓C. Yet, studies show that ↑i have no impact on C decisions. In U.S., assume that ∆ interest rates have no impact on the C f(x). 4. Future income expectations ● Expectations about future earnings influence consumer purchases today. ♦ Key to real world puzzle posed earlier. Why did tax policy succeed in 1964 and 1980s but fail in 1975 and 2001? ? Why The Tax Rebate Failed in 1975 and 2001 ● To understand how future incomes affect current C, consider 3 individuals in Table 2. ♦ “No change” earned $100 in all 4 years. ♦ “Temporary rise” earned $100 in 3 of 4 years, but had $120 income in 1975. ♦ “Permanent rise” earned $100 in first year and $120 in all future years. TABLE 2. Incomes of Three Consumers Consumer 1974 1975 1976 1977 Total Income No Change 100 100 100 100 400 Temporary Rise 100 120 100 100 420 Permanent Rise 100 120 120 120 460 ? Why The Tax Rebate Failed in 1975 and 2001 ● How much did each spend in 1975? ♦ Temporary and permanent rise had same income in 1975. ♦ Permanent rise probably spent more if she could foresee higher future earnings. ♦ Temporary rise has 20% more income than No change in 1975, but only 5% more income over all 4 years. ♦ Do you think Temporary’s spending was 20% higher or 5% higher than No change in 1975? ● Reasonable for consumers to decide current C by looking a LR income prospects. ? Why The Tax Rebate Failed in 1975 and 2001 ● Imagine 3 rows represent the entire economy under 3 different gov tax policies. ♦ No change is no tax cut; temporary rise is a temporary tax cut; and permanent rise is a permanent tax cut. ● 1975 was a temporary tax cut; and 2001 was believed to be a temporary tax cut –even thought it is still in place. ● Permanent cuts in income taxes induce a greater ↑C versus temporary cuts of equal magnitude. The Extreme Variability of Investment ● Investment spending is the most volatile of all spending components. ● I swings from high to low levels rapidly. When U.S. GDP fell by 2.8% from 2008-2009, I fell by 30%. ● Recall factors that influence I spending: ♦ ♦ ♦ ♦ Level and growth of AD Technological change and product innovation Real interest rate Tax provisions The Extreme Variability of Investment ● Business confidence and expectations for the future also determines firms’ desire for I. ♦ Firm owners buy more factories and equipment when they are optimistic. ♦ They are cautious if outlook is weak and reluctant to I. ♦ These perceptions are subject to abrupt shifts –”animal spirits.” ♦ We don’t know how to measure or control business confidence. The Determinants of Net Exports ● Highly variable source of demand for U.S. goods and services. ● National Incomes: an ↑Y → ↑D for all goods including those produced in foreign countries →↑IM. ♦ Our X↑ when GDP of other countries rises. ● Relative prices and exchange rates: differences in international prices influence a country’s net exports. ♦ ↑P level in U.S. → ↓X and ↑IM → ↓net exports ♦ If ↑$ → ↓X and ↑IM → ↓net exports How Predictable is Aggregate Demand? ● While the C f(x) seems like a simple tool, it is actually quite difficult to predict consumer spending. ♦ Unexpected movements in stock or housing market wreck forecasts of C ♦ Difficult to predict how consumers will view changes in tax policies –temporary vs permanent ● Swings in I are difficult to predict because business confidence and expectations are hard to measure or predict ● Unexpected developments abroad influence our net X ● G can also be unpredictable –e.g., ↑spending after 9/11

Aggregate Demand and the Powerful Consumer, Part 2

Related Documents

Recommended Documents

Description

Related Documents

Free up your schedule!

Take 5 seconds to unlock