Mc graw hillirwincopyright © 2012 by the mcgraw-hill com

1. McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All
rights reserved.
Chapter 10
Basic Macroeconomic
Relationships
McGraw-Hill/Irwin
Copyright © 2015 by McGraw-Hill Education. All rights
reserved.
*
This chapter introduces three basic macroeconomic
relationships. First, the focus is on the income-consumption
and income-saving relationships. Second, the relationship
between the interest rate and investment is examined. Finally,
the multiplier concept is developed, relating changes in
spending to changes in output.
Consumption and saving
Primarily determined by DI
Direct relationship
Consumption schedule
Planned household spending (in our model)
Saving schedule
DI minus C
Dissaving can occur
Income Consumption and Saving

2. LO1
*
DI represents disposable income (after-tax income) and is the
most important determinant of C (consumption spending). What
is not spent is called saving. Both consumption and saving are
directly related to the level of income.
We can make the following conclusions:
Households consume a large portion of their disposable income
and spend a larger proportion of a small disposable income than
of a large disposable income.
Households save a smaller proportion of a small disposable
income than of a large disposable income.
Dissaving is consuming in excess of disposable income.
Households dissave by borrowing or by selling accumulated
wealth (assets).
Income Consumption and Saving
LO1
*
This figure shows the consumption and disposable income for
the U.S. for 1987–2012. Each dot in this figure shows
consumption and disposable income in a specific year. The line,
C, which generalizes the relationship between consumption and
disposable income, indicates a direct relationship and shows
that households consume most of their after-tax incomes.
This figure represents graphically the recent historical
relationship between disposable income (DI), consumption (C),
and saving (S) in the United States.
A 45-degree line represents all points where consumer spending
is equal to disposable income. Other points represent actual C,

3. DI relationships for each year.
If the actual graph of the relationship between consumption and
income is below the 45-degree line, then the difference must
represent the amount of income that is saved. Notice that
consumption can exceed disposable income and personal saving
can be negative.
Consumption and Saving Schedules
LO1Consumption and Saving Schedules (in Billions) and
Propensities to Consume and Save(1)
Level of Output and Income
GDP=DI(2)
Consumption
(C)(3)
Saving (S),
(1) – (2)(4)
Average Propensity to Consume
(APC),
(2)/(1)(5)
Average Propensity to Save (APS),
(3)/(1)(6)
Marginal Propensity to Consume
(MPC),
Marginal Propensity to Save
(MPS),
-51.01-.01.75.25 390 390 01.00
.00.75.25 410 405 5 .99 .01.75.25 430 420 10 .98 .02.75.25
450 435 15 .97 .03.75.25 470 450 20 .96 .04.75.25 490 465
25 .95 .05.75.25 510 480 30 .94 .06.75.25 530 495 35 .93
.07.75.25(10) 550 510 40 .93 .07.75.25

4. *
This table shows the consumption and saving schedules and
propensities to consume and save (propensities to consume and
save will be presented in later slides).
A hypothetical consumption schedule shows that households
spend a larger proportion of a small income than of a large
income based on the APC. Note that “dissaving” occurs at low
levels of disposable income, where consumption exceeds
income and households must borrow or use up some of their
wealth.
The break-even income is where C= DI and S= 0. In this table,
the break-even income occurs when DI = $390.
Consumption and Saving Schedules

5. 390 410 430 450 470 490 510 530 550
C
S
Consumption
schedule
Saving schedule
Saving $5 billion
Dissaving $5 billion
Dissaving
$5 billion
Saving $5 billion
Consumption (billions of dollars)
Saving
(billions of dollars)
Disposable income (billions of dollars)
LO1
*
This figure shows (a) consumption and (b) saving schedules.
The two parts of this figure show the income-consumption and
income-saving relationships graphically. The saving schedule in
(b) is found by subtracting the consumption schedule in (a)
vertically from the 45° line. Consumption equals disposable
income (and saving, thus, equals zero) at $390 billion for this
hypothetical data.
Average Propensities
Average propensity to consume (APC)
Fraction of total income consumed
Average propensity to save (APS)
Fraction of total income saved
APC + APS = 1
LO1

6. LO1
APC =
APS =
consumption
income
income
saving
*
The definition of the average propensity to consume (APC) is
the fraction, or percentage, of income consumed (APC =
consumption/income). If you multiply the fraction by 100 you
can express this as a percentage. The definition of the average
propensity to save (APS) is a the fraction, or percentage, of
income saved (APS = saving/income). If you multiply the
fraction by 100 you can express this as a percentage.
The Global Perspective shows the APCs for several nations in
2009. Note the high APCs for Australia, the U.S., and Canada.
Note that APC + APS = 1.
Global Perspective
LO1
LO1
*
This Global Perspective shows the average propensities to
consume for selected nations. There are surprisingly large
differences in the average propensities to consume (APCs)
among nations. In 2011, Canada and the United States, in
particular, had substantially higher APCs, and thus lower APSs,

7. than several other advanced economies.
Marginal Propensities
Marginal propensity to consume (MPC)
Proportion of a change in income consumed
Marginal propensity to save (MPS)
Proportion of a change in income saved
MPC + MPS = 1
LO1
LO1
MPC =
MPS =
change in consumption
change in income
change in income
change in saving
*
Marginal propensity to consume (MPC) is the fraction or
proportion of any change in income that is consumed. (MPC =
change in consumption/change in income.) Marginal propensity
to save (MPS) is the fraction or proportion of any change in
income that is saved. (MPS = change in saving/change in
income.) Note that MPC + MPS = 1.
Marginal Propensities
Disposable income

8. Consumption
Saving
S
C
MPC =
MPS =
= .75
= .25
LO1
LO1
15
20
5
20
*
This figure shows the marginal propensity to consume and the
marginal propensity to save as the slopes of the consumption
and savings schedules. The MPC is the slope of the
consumption schedule and the MPS is the slope of the saving
schedule. The Greek letter delta means “the change in.”

9. Nonincome Determinants
Amount of disposable income is the main determinant
Other determinants
Wealth
Borrowing
Expectations
Real interest rates
LO2
LO2
*
Nonincome determinants of consumption and saving can cause
people to spend or save more or less at various income levels,
although the level of income is the basic determinant.
Wealth: An increase in wealth shifts the consumption schedule
up and the saving schedule down. In recent years, major
fluctuations in stock market values have increased the
importance of this wealth effect. A “reverse wealth effect”
occurred in 2000 and 2001 when stock prices fell dramatically.
Household debt: Lower debt levels shift the consumption
schedule up and the saving schedule down.
Expectations: Changes in expected future prices or wealth can
affect consumption spending today.
Real interest rates: Declining interest rates increase the
incentive to borrow and consume, and reduce the incentive to
save. Because many household expenditures are not interest
sensitive – the electric bill, groceries, etc. – the effect of
interest rate changes on spending are modest.
Other Important Considerations
Switching to real GDP

10. Changes along schedules
Simultaneous shifts
Taxation
Stability
LO2
LO2
*
Macroeconomic models focus on real domestic output (real
GDP) more than on disposable income. The figure on the next
slide reflects this change in the labeling of the horizontal axis.
Changes along schedules: Movement from one point to another
on a given schedule is called a change in the amount consumed.
A shift in the schedule is called a change in the consumption
schedule and is caused by one of the non-income determinants
of consumption.
Schedule shifts: Consumption and saving schedules will always
shift in opposite directions unless a shift is caused by a tax
change.
Taxation: Lower taxes will shift both schedules up since
taxation affects both spending and saving and vice versa for
higher taxes.
Stability: Economists believe that the consumption and saving
schedules are generally stable unless deliberately shifted by
government action.
Shifts of C & S Schedules
C0
S0
Real GDP (billions of dollars)
Consumption
(billions of dollars)
Saving

11. (billions of dollars)
C2
C1
S1
S2
0
0
-
+
LO2
LO2
*
This figure shows the shifts of the consumption and saving
schedules. Normally, if households consume more at each level
of real GDP, they are necessarily saving less. Graphically this
means that an upward shift of the consumption schedule (C0 to
C1) entails a downward shift of the saving schedule (S0 to S1).
If households consume less at each level of real GDP, they are
saving more. A downward shift of the consumption schedule
(C0 to C2) is reflected in an upward shift of the saving schedule
(S0 to S2). This pattern breaks down, however, when taxes
change; then the consumption and saving schedules move in the
same direction—opposite to the direction of the tax change.
Expected rate of return
The real interest rate
Investment demand curve
LO3
Interest-Rate-Investment Relationship
LO3

12. *
Investment consists of spending on new plants, capital
equipment, machinery, inventories, construction, etc. The
investment decision weighs marginal benefits and marginal
costs. The expected rate of return is the marginal benefit and
the interest rate (the cost of borrowing funds) represents the
marginal cost.
The expected rate of return is found by finding the expected
economic profit (total revenue minus total cost) as a percentage
of the cost of investment. The text’s example gives $100
expected profit on a $1000 investment, for a 10% expected rate
of return. Thus, the business would not want to pay more than a
10% interest rate on the investment. Remember that the
expected rate of return is not a guaranteed rate of return.
Investment carries risk.
The real interest rate, i (nominal rate corrected for expected
inflation), determines the cost of investment.
The interest rate represents either the cost of borrowed funds or
the opportunity cost of investing your own funds, which is
income forgone. If the real interest rate exceeds the expected
rate of return, the investment should not be made.
The investment demand schedule, or curve, shows an inverse
relationship between the interest rate and the amount of
investment. As long as the expected return exceeds the interest
rate, the investment is expected to be profitable.
Investment Demand Curve
ID
Investment
demand
curve
LO3
LO3(r)
and

13. (i)Investment
(billions
of dollars) 16%$ 014 512 1010 15 8 20 6 25 4 30 2 35 0
40
*
This figure, which can be found in the Key Graph section,
shows the investment demand curve. The investment demand
curve is constructed by arraying all potential investment
projects in descending order of their expected rates of return.
The curve slopes downward, reflecting an inverse relationship
between the real interest rate (the financial “price” of each
dollar of investing) and the quantity of investment demanded.
Shifts of Investment Demand
Acquisition, maintenance, and operating costs
Business taxes
Technological change
Stock of capital goods on hand

14. Planned inventory changes
Expectations
LO4
LO4
*
Shifts in investment demand (see the next slide for the figure
that represents the graph) occur when any determinant apart
from the interest rate changes. Greater expected returns create
more investment demand, shifting the curve to the right. The
reverse causes a leftward shift.
Changes in expected returns result because:
Acquisition, maintenance, and operating costs of capital goods
may change. Higher costs lower the expected return.
Business taxes may change. Increased taxes lower the expected
return.
Technology may change. Technological change often involves
lower costs, which would increase expected returns.
Stock of capital goods on hand will affect new investment. If
there is abundant idle capital on hand because of weak demand
or recent investment, new investments would be less profitable.
If firms are planning on increasing their inventories, investment
demand shifts to the right. If firms are planning to decrease
their inventories, investment demand shifts left. These planned
inventory changes are based on expectations of either faster or
slower sales. If the firm expects faster sales in the future, they
will add to inventory. If the firm expects slower sales in the
future, they will decrease inventories.
Expectations about future economic and political conditions,
both in the aggregate and in certain specific markets, can
change the view of expected profits.
Shifts of Investment Demand

15. Expected rate of return, r, and
real interest rate, i (percents)
0
Investment (billions of dollars)
ID0
ID1
ID2
Increase
in investment
demand
Decrease in
investment
demand
LO4
LO4
*
This figure shows the shifts of the investment demand curve.
Increases in investment demand are shown as rightward shifts of
the investment demand curve; decreases in investment demand
are shown as leftward shifts of the investment demand curve.
Global Perspective
LO4
LO4
*
This Global Perspective shows gross investment expenditures as
a percentage of GDP for selected nations for 2011. As a

16. percentage of GDP, investment varies widely by nation. These
differences, of course, can change from year to year.
Instability of Investment
Variability of expectations
Durability
Irregularity of innovation
Variability of profits
LO4
LO4
*
Investment is a very unstable type of spending. Ig is more
volatile than GDP. Expectations of future business conditions
are easily and quickly changed. Capital goods are durable, so
spending can be postponed or not. Firms can choose to replace
or fix older equipment and buildings. This is unpredictable.
Innovation occurs irregularly; new products stimulate
investment and create waves of investment spending that in time
recede. Profits affect both the incentive and ability to invest
and profits vary considerably from year-to-year, contributing to
the instability of investment spending.
Instability of Investment
LO4
LO4
*
This figure shows the volatility of investment for the period
1973–2012. Annual percentage changes in investment spending

17. are often several times greater than the percentage changes in
GDP. (Data is represented in real terms. Investment is gross
private domestic investment).
The Multiplier Effect
A change in spending changes real GDP more than the initial
change in spending
Change in GDP = multiplier x initial change in spending
LO5
LO5
Multiplier =
change in real GDP
initial change in spending
*
Changes in spending ripple through the economy to generate
even larger changes in real GDP. This is called the multiplier
effect.
Multiplier = change in real GDP / initial change in spending.
Alternatively, it can be rearranged to read: change in real GDP
= initial change in spending x multiplier.
Points to remember about the multiplier:
The initial change in spending is usually associated with
investment because it is so volatile, but changes in consumption
(unrelated to income), net exports, and government purchases
also are subject to the multiplier effect.
The initial change refers to an up-shift or down-shift in the
aggregate expenditures schedule due to a change in one of its
components, like investment.
The multiplier works in both directions (up or down).
It occurs because of the interconnectedness of the economy.

18. The Multiplier Effect
$5.00
$3.75
$2.81
$2.11
$1.58
$4.75
Cumulative income,
GDP (billions of dollars)
20.00
15.25
13.67
11.56
8.75

19. 5.00
2
3
5
4
All others
1
LO5
LO5(1)
Change in Income(2)
Change in Consumption (MPC = .75)(3)
Change in Saving
(MPS = .25)Increase in investment of
$5.00$5.00$3.75$1.25Second round 3.75 2.81 .94Third round
2.81 2.11 .70Fourth round 2.11 1.58 .53Fifth round 1.58
1.19 .39All other rounds 4.75 3.56 1.19
Total$20.00$15.00$5.00
*

20. This figure illustrates the multiplier process with an MPC of
.75. An initial change in investment spending of $5 billion
creates an equal $5 billion of new income in round 1.
Households spend $3.75 billion of this new income, creating
$3.75 of added income in round 2. Of this $3.75 of new income,
households spend $2.81 billion, and income rises by that
amount in round 3. Such income increments over the entire
process get successively smaller but eventually produce a total
change of income and GDP of $20 billion. The multiplier
therefore is 4.
Multiplier and Marginal Propensities
Multiplier and MPC directly related
Large MPC results in larger increases in spending
Multiplier and MPS inversely related
Large MPS results in smaller increases in spending
LO5
LO5
Multiplier =
1
1- MPC
Multiplier =
1
MPS
*
The significance of the multiplier is that a small change in
investment plans or consumption-saving plans can trigger a
much larger change in the equilibrium level of GDP. The
magnitude of the change in GDP is dependent on the size of the
MPC and MPS.

21. Multiplier and Marginal Propensities
10
5
4
3
2
.5
.67
.75
.8
.9
MPC
Multiplier
LO5
LO5
*
This figure illustrates the relationship between the MPC and the
multiplier. The larger the MPC (the smaller the MPS), the
greater the size of the multiplier.
The Actual Multiplier Effect?
Actual multiplier is lower than the model assumes
Consumers buy imported products
Households pay income taxes
Inflation
Multiplier may be 0
LO5
LO5

22. *
The actual multiplier in the U.S. (estimated to be between 2.5
and 0) is smaller than the model in this chapter because, in the
U.S. economy, there are other leakages from the spending and
income cycle besides just saving. Imports and taxes reduce the
flow of money back into spending on domestically produced
output, reducing the multiplier effect. Also, increases in
spending can drive up prices (inflation) and at higher prices,
any given amount of spending will buy less real output.
Squaring the Economic Circle
Humorous small town example of the multiplier
One person in town decides not to buy a product
Creates a ripple effect of people not spending, following the
first decision
Ultimately the entire town experiences an economic downturn
*
The central idea illustrated in this example is of the multiplier
effect that exists in a market economic system. One
independently determined change in spending has an effect on
another’s income, which then sets in motion a chain of events
whereby spending changes directly with the income changes. A
decline in spending begins a chain of declines, or, in other
words, the initial decrease in spending is multiplied in terms of
the final effect of this single decision. This occurs because of
the observation that any change in income causes a change in
spending that is directly proportional to it. The multiplier
effect helps us understand why there is a business cycle as
opposed to a stable level of output growth from year to year. In
the Buchwald piece, a “downturn” for one person became a
downturn for everyone in that fictional economy. Likewise, if

23. the story had begun with a burst of optimism and an increase in
spending, it might have rippled through to expand everyone’s
fortunes.
The multiplier intensifies the effect of a spending change,
whether it is an increase or decrease.
The multiplier is based on two facts:
1. The economy has continuous flows of expenditures and
income—a ripple effect—in which income received by one
comes from money spent by another, and so forth.
2. Any change in income will cause both consumption and
saving to vary in the same direction as the initial change in
income.
Chapter 10 Lecture Summary
Lecture presentation - Chapter 10
The lecture presentation is in the form of a Power Point
presentation, basically an introduction to the chapter.
By now you should have viewed the entire presentation. You are
to type up an outline/summary of the presentation. Your outline
or summary should be no more than 3 pages, doubled spaced.
You must use MS Word to type up your assignment.
PEER RESPONSES:
CH 1
DOMINIQUE’S POST:
I have been attending SUSLA since August of 2017. My
graduation date would have been December of this year. I was
enrolled in the nursing program. Fall of 2020 I dropped out of
the program. Looking back, at this time is when I began to
apply the scientific method to my life. I had to reevaluate a lot
of things in my life. I had to decide, is nursing really for me; is
this really what I want to do. I evaluated the things that I felt
were hindering my education, such as time management, not
having a babysitter, and finances. I sat out of school while I
worked to save money to start the program again. I enrolled my
children into daycare, and I have begun to manage my time. I

24. came up with a solution to rid myself of those problems. I am
now more determined than ever to get back into the nursing
program and complete what I started.
JENNIFER’S POST:
I worked for a boat manufacturing company for about five years
as a supervisor in different spots and loved what I did then out
of the blue one day we find out that we no longer have a job
that the company is going out of business, so starts the
scientific method applied to my life. The first thing I did was
ask myself the question of what next, looked at finances
because my husband worked at the same place so he was
without a job too, he went back to work at a really good job
while I tried to find work for the first three months thru web
sites like Indeed.com, Monster.com, and finally laworks.net.
while on laworks.net I discovered that they have different
programs that you can apply for that will help you to find
another job or go back to school to better your education or
learn a new trade. I set up appointments with the WFC
counselors, which by the way was hard to do because we were
in the middle of a pandemic, got a list of schools that were in
the program, and started to research what I wanted to do, then
what school I wanted to attend. I found SUSLA on the list and
decide to do a little research on it by looking at SUSLA.org,
facebook/susla.com, and look at some articles that were on
usnews.com. After gaining an overview of the school and what
they stand for I came to a conclusion. I filled the proper
paperwork, submitted the forms that needed to be submitted,
and started this new, exciting, very scary next step in my life.
CH 2
TENAE’S POST:
Creative Destruction is getting rid of one product to replace it
with a better up to date one, such as CD's going out of style
because now you can stream music on different apps from your
phone. Self driving car may cause for certain vehicles to go out
of style because everyone will want a car to drive itself. It may
also take a toll on uber drivers as well.

25. TANADJA’S POST:
According to investopedia.com, creative destruction is the
dismantling of long-standing practices in order to make way for
innovation and is seen as a driving force of capitalism. It is mist
often used to describe disruptive technologies such as the
railroads or, in our own time, the internet. In simple terms, it is
when a new invention destroys what came before it. The process
of creative destruction is essential fact about capitalism.
The idea of self driving cars is to build a car with cameras that
can track all the object around it. According to
coalititionforfuturemobility.com, automation(self-diving cars)
can help reduce the number of crashes on the road and save
drivers more money due to low accident-induced costs.
Self-driving car ideas were put in to motion to replace the
cars/trucks/SUV's that we all use in today's society. They plan
to take over as our prime source of transportation. I don't agree
with the self driving car industry but in the near future, I see
them taking over.
CH 3
LANEISHA’S POST:
My example of a paradox of thrift would be my life dealing with
the effects of Covid 19 and the layoffs. With the layoffs came
unemployment and an adjustment in the household finiances and
a more of a set budget. When you have a change in your
household you have to do the things thats more of an
importance and a priority over other things. So you have to
worry abour bills and food for your household gas in your
vehicles and other entertainment. The effect of the pandemic
causes a ripple in the economy, where if the spending slows
down then we can feel the effects in the entertainment side due
to slowness. There will be a slowing down to refuction in hours
and employee availaibilty. The type of service offerd when we
go to theaters, resturants and grocery stores is all tied back into
the pandemic.

26. JA’QUAN’S POST:
There have been numerous experiences that I have encountered
in my life that I would acknowledge as a "paradox of thrift."
Considering that this cycle represents individuals actions that
have unintended consequences, I would say all of us have
experiences in our life that represent this cycle. For example,
there have been many of times, this same school year to be
exact, that I was not in the mood to study my material.
Sometimes, I fell weak to this feeling and decided, because I
did not feel like studying that I would not do it. The unintended
consequence for that was making a poorer grade on my
assignment or exam, for the individual prudent action I decided
to take.
CH 7
JENNIFER’S POST:
According to an article from CNBC.com/2020/14/heres-why-
this-recession-has-been-diffrent-from-any-other.html
This recession looks so different due to the fact that the 2.3
Trillion dollar bailout that Congress approved took some of the
burdens of people but that is only going to provide a short term
solution once the stimulus money runs out for some paying rent,
utilities, insurance for a vehicle to try and find a job, or to pay
someone to keep your kids because the day care is closed or too
expensive with no job than you re right back at square one, no
money, no job, only this time there is no help coming. The
unemployment rate is still high and those that really want to go
back to work are taking jobs that they are way overqualified for
at a pay rate that still does not allow them to maintain the
lifestyle that they had before, therefore they are still having to
relocate. It's just a vicious cycle that is going to get worst as
time goes along.
Another issue is the price of food and utilities rising and the
cost of living not. People cant survive on what they make now.
Companies are struggling to stay alive and can't afford to pay
more and stay open, but you can't work for what they are paying

27. and manage to keep a roof over your head and food in your
tummy. The state is not much help either with all the
restrictions and maximums that they have in place.
TENAE’S POST:
Based on the Covid 19 pandemic I do believe a recession could
look worse than what it is because even though a lot of people
are without jobs and shelter there's still people who's lives
improved drastically due to the pandemic, from monthly
stimulus checks to even scamming and personal business loans.
Many health care workers also received a boost in their salary.
According to NY times this is the worse recession as far as job
losses.
CH 9
JA’QUAN’S POST:
The impact of Covid-19 in the United States has been extremely
substantial. Many businesses have shut down, leading to
unemployment of many people depending on these jobs in order
to make a living. In fact in April 2020, the unemployment
peaked at 14.8% during the highest lowest point of the
recession. That has decreased to 5.4% in July 2021, but as you
can see, this has been no joke.
The market I would say that has been influenced the most by
Covid-19 would be the health industry. Due to many people
becoming sick and the substantial need of vaccinations has led
to a boom in the need of medical workers and healthcare
service. Doctors, nurses, and healthcare workers have never
been as important as they are in this day and age.
LANEISHA’S POST:
The pandemic was the hardest recession this world has every
faced and will take the longest to recovery from if that is even
possible. There was a lot of lives torn apart by this recession
and the top 10 business that were impacted by Covid 19 are
Public transportaion, Airllines, Food Services, Resturants,
Fitness Centers, Healthcare, Hotels, Beauty and Personal Care,
Performing Arts, Movie Theaters, Retail etc.. Although we see a
rise in the wages in some company's the adjustment is still hard

28. for some due to inflation in 2021.
https://www.gobankingrates.com/money/business/the-industries-
that-have-changed-the-most-due-to-covid-
19/?utm_campaign=1063597&utm_source=msn.com&utm_conte
nt=21
CH 10
LANEISHA’S POST:
The fundemental reason that the levels of consumption and
savings in the United States are higher today than decades ago
is due to the downshift of the consumption. This typically
involves an equal upshift in the savings schedule because you
can only use your money when it comes to consumption or
savings. The schedule shifts up due to an increase in savings
and reduced consumption declines due to a reduction.
TENAE’S POST:
The exception of the consumption schedule relationship is when
there is an increase in personal taxes, after than they both move
the same direction.