Chapter 13 Flashcards
What is consumption?
Household spending on final goods and services.
It includes spending on food, rent, clothes, dental bills, cars, internet services, electricity, etc.
Consumption is the single largest component of GDP.
What is the consumption function?
A curve plotting the level of consumption associated with each level of income.
What does an upward-sloping consumption function indicate?
More income leads to more consumption.
What does the marginal propensity to consume determine? What is it and what is the formula?
The slope of the consumption function. The fraction of each extra dollar of income that households spend on consumption.
= change in consumption / change in income
If the average marginal propensity to consume is 0.4, how much will consumption rise with an $800 million increase in total income?
$320 million.
What is saving? What is the formula?
The portion of income that you don’t spend in a given period.
Savings = Income - Consumption
What is dissaving?
The excess amount you consume above your income in a given period.
What counts as saving?
Putting unspent income in the bank or investing, using unspent income to pay down existing debt.
Why is saving important from a microeconomic perspective?
Savings adds to your wealth and boosts your consumption in the future.
What is net wealth?
The amount by which your assets exceed your debts. = stock of savings - debt
What is consumption smoothing?
Maintaining a steady or smooth path for your consumption spending over time.
What is the permanent income hypothesis? What is permanent income?
The idea that consumption is driven by permanent income rather than current income.
Best estimate of long term average income
What happens when there is a temporary change in income?
It leads to a small change in consumption.
What happens with a permanent change in income?
It leads to a large change in consumption.
What is the effect of an anticipated change in income on consumption?
It leads to no change in consumption.
What triggers a change in consumption according to the learning insight?
Getting news about future income changes.
Why is it hard to forecast changes in consumption?
Changes in consumption are driven by reactions to unexpected news.
What does the rational rule for consumers suggest?
Consume more today if the marginal benefit of a dollar of consumption today is greater than (or equal to) the marginal benefit of spending a dollar plus interest in the future.
What are flows in the context of saving and consumption?
New saving, consumption, and income in a specific period of time.
How does consumption smoothing relate to diminishing marginal benefit?
You can increase your total benefits by reallocating a dollar of consumption from a time of plenty to a time of relative poverty.
What is difficult to forecast regarding consumption?
Changes in consumption due to unanticipated news
Changes in individual consumption are hard to predict, making total consumption forecasting equally challenging.
What are credit constraints?
Limits on how much you can borrow
Banks often require collateral, which affects borrowing ability.
What defines hand-to-mouth consumers?
They spend their income as they receive it and do not smooth consumption
Their marginal propensity to consume is 1.
What happens to consumption with a temporary change in income for hand-to-mouth consumers?
Large change in consumption
Consumption smoothers experience a small change.
What is the effect of a permanent change in income on consumption?
Large change in consumption for both consumption smoothers and hand-to-mouth consumers.
What is the impact of anticipated changes in income on consumption for hand-to-mouth consumers?
Large change in consumption
Consumption smoothers experience no change.
What are the four factors that shift the consumption curve?
- Real interest rates
- Expectations
- Taxes
- Wealth
Changes in income do not shift the consumption curve.
How do high real interest rates affect consumption?
They typically lead to a decrease in consumption
The substitution effect reduces current consumption, while the income effect has mixed results.
What is the relationship between consumer expectations and consumption?
Optimistic expectations lead to higher consumption; pessimistic expectations lead to lower consumption.
What is disposable income?
Your after-tax income.
What happens to consumption when there is a tax cut?
Increases in disposable income, leading to higher consumption.
What is the effect of wealth on consumption?
Greater wealth translates into higher consumption.
What is precautionary saving?
Saving to be prepared for a financial emergency.
What do most people tend to do with their savings over their life cycle?
Borrow when young, save in midlife, and spend down savings in retirement.
What are the four motivations to save?
- Changing income over the life cycle
- Changing needs over the life cycle
- Bequests
- Precautionary saving
What is the rational rule for consumers regarding spending?
Shift spending to times when it yields the largest marginal benefit.
How does a rise in housing prices affect the consumption function?
Consumption function shifts up (increase in wealth).
What happens to the consumption function when the Bank of Canada raises interest rates?
Consumption function shifts down (increase in real interest rates).
What is the formula for savings?
Savings = Income − Consumption.
