Transcript MPC MPS and Investment demand

Unit 3—Aggregate
Models
Krugman Section 4 Module 16
Graphs: 5
Time: 2 weeks
Consumption & Saving
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What can a person do with disposable income
(money earned after taxes)?
What is not spent is called savings
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DI – C = Savings
Graphs
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Consumption in notes
Savings in notes
Consumption Savings Link
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Big graph number 4
Average Propensities to C & S
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Measures the average C (APC) or S (APS) at
any level of disposable income
APC = C / DI
APS = S / DI
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C%  and S%  as DI 
APC + APS = 1
Marginal Propensities to C & S
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(marginal means extra)
Proportion of any change in income C is called MPC
or income Saved is called MPS
MPC = ∆ C / ∆ DI
MPS = ∆ S / ∆ DI
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MPC + MPS = 1
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The only choice people have is to C or to Save. An
additional dollar in income must result in a change in C
and/or a change in Savings.
Practice Worksheet
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APC/APS
MPC/MPS
Investment Demand Curve
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BIG GRAPH #5
Investment
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Spending on new plants, capital equipment,
machinery, construction, etc.
Investment decision weighs mb & mc
The expected rate of return = mb
The interest rate = mc
Expected Rate of Return
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Found by comparing the expected economic
profit (total revenue minus total cost) to cost of
investment to get expected rate of return
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Woodworker wants to buy equipment for $1,000.
He expects a $100 profit. The expected rate of
return in 10%. In order to make a profit, the
woodworker would not want to pay more than
10% interest on the investment.
The Real Interest Rate
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The real interest rate, i, is the cost of the
investment
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Real interest rate = nominal rate - inflation
If i > expected rate of return, r, the investment
should not be made
Shifts in the Investment Demand
Curve—IDC or DIgC
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Movement occurs with a change in the interest
rate
Shifts occur due to these determinants:
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1. acquisition, maintenance and operating costs
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When cost falls, the r from prospective investment
project rises, shifts the IDC to the right
Higher electricity costs = shift to the left
2. business taxes
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in taxes = shift to the left
Shifts Continued
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3. technological change
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Development stimulates investment
(shifts to the right)
4. stock of capital goods on hand
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When firms are overstocked, the r declines
(shifts to the left)
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There is little incentive to invest in new capital
when there is excess production
When firms are under stocked, the r increases
(shifts to the right)
Shifts continued again . . .
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5. Expectations
Optimistic about future sales, the curve will
shift to the right
 Pessimistic outlook = shift to the left
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