Examining the effects of a change in real disposable income on equilibrium price and output

Economics — Economics is a social science concerned chiefly with description and analysis of the production, distribution, and consumption of goods and services according to the Merriam-Webster Dictionary.

Examining the effects of a change in real disposable income on equilibrium price and output

The current income hypothesis Consumption in any one period depends on income during that period. Although it seems obvious that consumption should be related to disposable personal income, it is not so obvious that consumers base their consumption in any one period on the income they receive during that period.

Examining the effects of a change in real disposable income on equilibrium price and output

In buying a new car, for example, consumers might base their decision not only on their current income but on the income they expect to receive during the three or four years they expect to be making payments on the car.

Parents who purchase a college education for their children might base their decision on their own expected lifetime income. Indeed, it seems likely that virtually all consumption choices could be affected by expectations of income over a very long period.

One reason people save is to provide funds to live on during their retirement years.

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Another is to build an estate they can leave to their heirs through bequests. The amount people save for their retirement or for bequests depends on the income they expect to receive for the rest of their lives.

For these and other reasons, then, personal saving and thus consumption in any one year is influenced by permanent income. Permanent income The average annual income people expect to receive for the rest of their lives. People who have the same current income but different permanent incomes might reach very different saving decisions.

Someone with a relatively low current income but a high permanent income a college student planning to go to medical school, for example might save little or nothing now, expecting to save for retirement and for bequests later.

A person with the same low income but no expectation of higher income later might try to save some money now to provide for retirement or bequests later. Because a decision to save a certain amount determines how much will be available for consumption, consumption decisions can also be affected by expected lifetime income.

Thus, an alternative approach to explaining consumption behavior is the permanent income hypothesis Consumption in any period depends on permanent income. An important implication of the permanent income hypothesis is that a change in income regarded as temporary will not affect consumption much, since it will have little effect on average lifetime income; a change regarded as permanent will have an effect.

The current income hypothesis, though, predicts that it does not matter whether consumers view a change in disposable personal income as permanent or temporary; they will move along the consumption function and change consumption accordingly. The question of whether permanent or current income is a determinant of consumption arose in when President George H.

Consumption (economics) | regardbouddhiste.com Most Economists believe that the classical model cannot explain the short- run economic fluctuations because in this model prices are flexible.
2 Households and Wage Setting Behind that adjustment, however, lie two distinct effects:

Bush ordered a change in the withholding rate for personal income taxes. Workers have a fraction of their paychecks withheld for taxes each pay period; Mr.

Bush directed that this fraction be reduced in The change in the withholding rate did not change income tax rates; by withholding less intaxpayers would either receive smaller refund checks in or owe more taxes.

Economists who subscribed to the permanent income hypothesis predicted that the change would not have any effect on consumption. Those who subscribed to the current income hypothesis predicted that the measure would boost consumption substantially in That is considerably less than would be predicted by the current income hypothesis, but more than the zero change predicted by the permanent income hypothesis.

This result, together with related evidence, suggests that temporary changes in income can affect consumption, but that changes regarded as permanent will have a much stronger impact.

Many of the tax cuts passed during the administration of President George W. Bush are set to expire in The proposal to make these tax cuts permanent is aimed toward having a stronger impact on consumption, since tax cuts regarded as permanent have larger effects than do changes regarded as temporary.

Other Determinants of Consumption The consumption function graphed in Figure Changes in disposable personal income cause movements along this curve; they do not shift the curve.The economy will reach equilibrium in a simple economy only if saving is a.

greater than investment. b. less than investment. c. equal to investment. d. equal to disposable income. Since inflation doesn't change in the short run, the Fed doesn't change real interest rates so that investment doesn't change.

In the long-run, however, the recessionary gap means that SRAS shifts down until the economy is back at potential output but at . Measuring fiscal impetus: The Great Recession in historical context Leslie McGranahan and Jacob Berman to real GDP percentage change as measured in the NIPAs (table ) with the modification that we adjust for disposable income and stimulate private demand.

Net migration is a function of disposable household income (YD H) divided by the domestic price level (CPI H) and the local unemployment rate, the relative [End Page ] number of nonworking households (HN H) to total households. 2a. Consumption and disposable income (before-tax income less taxes paid) are as follows: Disposable income Consumption 22, 20, 23, 21, 24, 22, 26, 23, What is the marginal propensity to consume?

If disposable income increases by from 22, to 23,, a rise of , consumption rises by In the aggregate expenditures model, equilibrium is found at the level of real GDP at which the aggregate expenditures curve crosses the degree line.

The wedge between disposable personal income and real GDP created by taxes means that the additional rounds of spending induced by a change in autonomous aggregate .

Chapter Spending, Output, and Fiscal Policy - [PPT Powerpoint]