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Income and Consumption

Determinants of Consumption and Saving



Determinants of Consumption and Saving

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So now let's think about the determinants of consumption and saving, what causes the consumption function to look the way that it does. So when we think about the consumption function, remember we had um let me go down here and I'll draw a little consumption function right here. So we had our graph where we had our consumption increasing as disposable income increased, right? So what could cause that consumption function to change? Right? Remember this is the marginal propensity to consume being the slope, right? The slope being the marginal propensity to consume. But what could cause us to move say from this consumption function maybe up here to a different consumption function way up there while we're still keeping the same balance of how much we're saving or consuming, what can cause it to shift up or down. So let's think about some of those uh some some of those determinants of our consumption and saving. So the consumption function could shift up or down when factors other than the disposable income changes. Right? So this kind of follows when when we were talking about shifting supply and demand, right? It was factors other than price that were changing in this case, when we deal with consumption, it's disposable income is our variable. So when other things other than disposable income change, well, that's going to affect our consumption function. So let's see what some of those might be. The first one here is a sudden change in wealth. So wealth being the accumulation of money that you have, right? So when we have an in these examples, we have an unexpected increase in stock prices. So, you own all these stocks, you have some of your savings in stocks and all of a sudden those stocks bump up 25% You weren't expecting to have all that extra wealth, Right? So you have this extra value, this extra wealth, what's gonna lead to an increase in consumption? Right? So that can cause a shift up, right? This can cause a shift up in the consumption function where we're consuming more. The opposite would be a crash, right? An unexpected crash, like in the real estate market in 2009? Well, that caused a decrease in consumption, right? So that would be a shift down. So these unexpected changes in wealth are going to affect our consumption just like that. What about borrowing borrowing is another one here that can affect the consumption function if we're borrowing money. Well, that's going to lead to an increase in current consumption, right? If we're borrowing money, that means we've got more money available now, we're gonna spend a little bit more now. But But what what cost it's gonna come at the cost of future consumption because we have to pay interest, right, just like I said down here, the interest cost of borrowing leads to a decrease in our future wealth. So later on when we have to repay the loan. Well, we're gonna have to decrease our consumption to match that. But borrowing tends to lead to current increases the next one is our expectations. So we can have expectations about the future. And if those those expectations can cause our consumption to change based on whether we expect an increase or a decrease. So if we expect prices to increase in the future. So say you're thinking about buying a house and you're like, should I buy a house now or should I buy a house later? Well if you expect prices to be higher later, you would probably want to buy the house now. Right? So if prices are expected to increase in the future current consumption would increase right? We would want to consume now rather than later. If we think prices are going to be higher later. Well we're gonna buy them now at the cheaper prices. So that increase is going to shift us up. Um just like an in an increase in income if we're expecting to have more income in the future. So now your boss tells you, right, oh you're going to get a 20% raise next year. So you have an expectation about higher money in the future? Higher higher salary in the future. Well you might increase your consumption now. You might start counting those eggs a little early and you would increase your current consumption on the other the flip side of it. Well what if you're expecting a recession right, what if you're expecting everything to come crashing down? Well you would probably uh decrease your current consumption because you want to be ready for that recession. You want to have some extra savings right? For for when things are a little tougher. So notice that a lot of these things are very logical, right? You you would expect these things to kind of follow and that happens a lot in macro economics where you kind of your your gut feeling of how things are gonna flow, that's generally what's gonna happen. So what about this last one real interest rates, A low real interest rate leads to. So what happens when we have low interest rates? Low interest rates is going to increase current borrowing, right? Because it's a low interest rate, it doesn't cost a lot to to borrow. So you're going to increase your current borrowing and increase your consumption. So you might buy more goods purchased with credit, right? Purchase with credit like a car and you have less of an incentive to save because low interest rate, right? Low interest rate. There's no reason to save. Um So you would increase your consumption there. So these things are pretty pretty straightforward, right? They all seem uh like they make sense of why they would affect consumption here. So let's go ahead and pause and let's do a practice problem down below

The country of Consumptia has had a booming economy for nearly a decade. However, prices have been rising faster than income, leading analysts to believe that a recession is on the horizon. If the citizens of Consumptia expect a recession in the coming years, then: