ECON 201 Lecture Notes - Lecture 15: Nominal Rigidity, Loanable Funds, Autonomous Consumption

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5 Feb 2017

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Econ 201 Lecture 15 Consumer/Investment Spending Part 1
Assume firms have fixed all prices
o Ignore inflation for now
o This is what is sometimes called a “sticky prices” assumption
Assume interest rate r is fixed
o This means that people’s savings behavior is fixed
o The market for loanable funds is in equilibrium
Assume no government (G = 0)
Assume no trade (NX = 0)
Spending is always income
o Spending = income
o Let’s say you have money (new income) that you need to get rid of and
you buy a bunch of stuff with it. That is new income to people.
Spending Multiplier
When you earn some income, you will spend some of it (consumption) and save
some it
o Y = C + S
o How much they consume depends on their wealth and their preferences
o Whatever they spend will become new income to someone else
o Process repeats
o I spend 1 million dollars
o The people who get that 1 million dollars, spends 500 thousand and saves
the other 500 thousand
o So far, there is 1.5 million of new income
o Whoever gets that 500 thousand will spend some and save some
o Etc. keeps going
The 1 million of new spending in the example above is called autonomous
o Means that it happened for some outside reason
o It also leads to more than 1 million of new income
o The amount more that’s spent depends on consumer behavior
Marginal Propensity to Consume (MPC)
o How much of an additional dollar you will consume
o Ex. If you get $1 and you consume 75 cents, MPC = .75
Marginal Propensity to Save (MPS)
o What’s left after you consume
o MPS = 1 MPC
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