<<SLIDE 2>> RECAP

The gross domestic product (GDP) is one of the primary indicators used to gauge the health of a
country's economy. It represents the total dollar value of all goods and services produced over a specific
time period; you can think of it as the size of the economy.

Consumption - is normally the largest GDP component in the economy, consisting of private
expenditures in the economy (household final consumption expenditure).

Investment - includes, for instance, business investment in equipment, but does not include exchanges of
existing assets. Examples include construction of a new mine, purchase of software, or purchase of
machinery and equipment for a factory.

Government Spending - is the sum of government expenditures on final goods and services. It includes
salaries of public servants, purchases of weapons for the military and any investment expenditure by a
government. It does not include any transfer payments, such as social security or unemployment benefits.

Net Exports - is the nation's total net exports, calculated as total exports minus total imports (NX =
Exports - Imports).

<<SLIDE 3: INTRO CONSUMPTION, INCOME, SAVING>>

Durable goods - is a good that does not quickly wear out, or more specifically, one that yields utility over
time rather than being completely consumed in one use. These include automobiles, books, household
goods, sports equipment, jewelry, medical equipment, firearms, and toys.

Non-durable goods or consumables are the opposite of durable goods. They may be defined either as
goods that are immediately consumed in one use or ones that have a lifespan of fewer than 3 years.
Examples are food, cosmetics, fuel, clothing, footwear, office supplies, etc.

Services is the most rapidly growing sector under consumption. It is used for the direct satisfaction of
individual needs or wants or the collective needs of members of the community.

Personal Savings is the residual income after deducting all expenditures.

Disposable Income or disposable personal income is the amount of money that households have
available for spending and saving after income taxes have been accounted for. Disposable personal
income is often monitored as one of the many key economic indicators used to gauge the overall state of
the economy.

Formula: Y = Income Personal Taxes

Discretionary income is the amount of income that a household or individual has to invest, save or
spend after taxes and necessities are paid. Discretionary income is similar to disposable income because
it's derived from it; however, there is one key difference. Disposable income does not take necessities into
account. Necessities a household or individual may have are rent, clothing, food, bill payments, goods and
services, and other typical expenses.
 <<SLIDE 5: Income>>

The classic consumption function suggests consumer spending is wholly determined by income and the
changes in income. If true, aggregate savings should increase proportionally as gross domestic product
(GDP) grows over time. The idea is to create a mathematical relationship between disposable
income and consumer spending, only on aggregate levels.

At all points, the saving/dissaving and consumption should always sum up to disposable income.

3 scenarios: Savings, Dissaving, Break-even.

<<SLIDE 6: Consumption Function>>

Consumer Spending the sum of autonomous consumption and marginal propensity to consume
multiplied to the disposable income.

Autonomous consumption is the minimum level of consumption or spending that must take place even if
a consumer has no disposable income, such as spending for basic necessities.

This contrasts with discretionary consumption, which is used for non-essential items. When combined
with discretionary income, a person's autonomous consumption determines his or her real income, or real
wages.

Marginal Propensity to Consume is the extra amount that people consume when they receive an extra
amount of disposable income.

<<SLIDE 7: Graph of Consumption Function>>

<<SLIDE 8: Determinants of Consumption>>

1. Consumer Disposable Income based on the formula, Y is an independent variable. An increase

in disposable income (Y) causes an increase in consumption (C), and vice-versa.
2. Permanent Income and the Life-Cycle Model of Consumption:
Permanent-income theory: This approach implies that consumers do not usually respond to all
income shocks.
Ex: A change in income appears permanent (a job promotion to a high-paying and secure
job) normally causes people to consume a large fraction of the increase in income.
Life-cycle hypothesis: People tend to save while working so as to build a nest egg for retirement
and then spend out their accumulated savings in their twilight years.
Ex: Programs like social security for retirement.
3. Wealth and Other Influences
Ex: Consider 2 consumers, both earning $50,000 per year. One has $200,000 in the bank,
while the other has no savings at all. The first person may consume part of wealth while
the latter has no wealth to draw down.

<<SLIDE 9: Investment Function>>

Short-run investment since investment is a large and volatile component of spending, it often leads to
changes in aggregate demand and affects the business cycle.

Aggregate demand (AD) - or domestic final demand (DFD) is the total demand for final goods and
services in an economy at a given time. It specifies the amounts of goods and services that will be
purchased at all possible price levels. This is the demand for the gross domestic product of a country.

Long-run investment leads to capital accumulation; adding to the stock of buildings and equipment
increases the nations potential output and promotes economic growth in the long-run.

Aggregate supply (AS) or domestic final supply (DFS) is the total supply of goods and services that
firms in a national economy plan on selling during a specific time period. It is the total amount of goods
and services that firms are willing and able to sell at a given price level in an economy.

Financial investments are not real investment because it is simply a transfer of existing assets.

<<SLIDE 10: Induced Investment>>

Induced Investment - when income increases, consumption demand also increases and to meet this,
investment increases. It increases or decreases with the rise or fall in income.

(I1, Y1) is the investment curve which shows induced investment at various levels of income.

(0, Y1) Induced investment is zero.

When income rises to OY3 induced investment is I3Yy A fall in income to OY2 also reduces induced
investment to I2Y2.

<<SLIDE 11: Autonomous Investment>>

Autonomous Investment - Investment in economic and social overheads whether made by the
government or the private enterprise is autonomous.

Ex: Expenditures on building, dams, roads, canals, schools, hospitals, etc.

Public investments - Since these are generally associated with public policy.

Diagrammatically, autonomous investment is shown as a curve parallel to the horizontal axis as (I1,I1)
curve in Figure 2. It indicates that at all levels of income, the amount of investment (O,I 1) remains
constant.

The upward shift of the curve to (I2,I) indicates an increased steady flow of investment at a constant rate
(O,I2) at various levels of income. However, for purposes of income determination, the autonomous
investment curve is superimposed on the curve in a 45 line diagram.

<<SLIDE 12: Graph of Investment Function>>