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© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4th edn
Chapter 6
Private Sector Demand:Consumption and
Investment
© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4/e
Variability of GDP Components, 1970-2001
0%
2%
4%
6%
8%
10%
12%
14%
C/Y I/Y G/Y
Consumption Investment GovernmentConsumption
USA
euro area
Fig. 6.01
© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4/e
Con
sum
ptio
n to
mor
row
0
Indifference curves: Normal case
Consumption today
Fig. 6.02(a)
© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4/e
Con
sum
ptio
n to
mor
row
0
Indifference curves: Zero substitution
Consumption today
Fig. 6.02(b)
© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4/e
Con
sum
ptio
n to
mor
row
0
Indifference curves: Constant substitution
Consumption today
Fig. 6.02(c)
© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4/e
Con
sum
ptio
n to
mor
row
0
Optimal consumption: borrower
IC1
IC2
IC3
B
D
R
C1
C2
M
Y1
Y2
(i)
(i) Consumption today financed on credit
(ii) (ii) Consumption loan repayment (including interest)
Fig. 6.03
-(1+r)
Consumption today
© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4/e
Con
sum
ptio
n to
mor
row
0
Optimal consumption: lender
A
Y1
Y2
B
IC1
IC2
IC3
D
R
C1
C2
(i)
(i) Saving from this period’s income
(ii)
(ii) Additional consumption next period
Fig. 6.03
Consumption today
-(1+r)
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Burda & Wyplosz MACROECONOMICS 4/e
Borrowing
Saving
Time
Income,Consumption
0
Life-cycle consumption
Income
ConsumptionPermanentincome
Fig. 6.04
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Burda & Wyplosz MACROECONOMICS 4/e
Temporary vs. permanent income changeC
onsu
mpt
ion
tom
orro
w
0
R´
A´´R´´
Y1
Y2
Y1´ B
D
A=R A´
B´ B´´
D´
Temporary: R to R´
Permanent: R to R´´
Fig. 6.05
Consumption today
Y2´
© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4/e
Real GDP and retail sales growth:Czech Republic, 1997-2002
Fig. 6.06
-10
-8
-6
-4
-2
0
2
4
6
8
10
12
Q 1/1997 Q 1/1998 Q 1/1999 Q 1/2000 Q 1/2001 Q 1/2002
Gro
wth
in
re
al
GD
P a
nd
sa
les
(% p
er
an
nu
m)
Retail sales real GDP
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Burda & Wyplosz MACROECONOMICS 4/e
Real price of crude oil, 1956-2002
Fig. 6.07
0
50
100
150
200
250
300
350
400
450
1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000
Ind
ex (
1995
=10
0)
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Burda & Wyplosz MACROECONOMICS 4/e
-6
-4
-2
0
2
4
6
8
1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000
Netherlands
Denmark
United Kingdom
Current accounts in three countries, 1956-2002
Fig. 6.08
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Burda & Wyplosz MACROECONOMICS 4/e
Effect of an increase in the interest rate: negative income effect for borrowers, positive for lenders
(a) Student Crusoe(borrower)
(b) Professional athlete(lender)
Consumption today
Con
sum
ptio
n to
mor
row
Consumption todayC
onsu
mpt
ion
tom
orro
w
B´ B
D
B
D
B´
A
A
R R
R´
R´
Fig. 6.09
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Burda & Wyplosz MACROECONOMICS 4/e
300
400
500
600
700
800
900
1000
1100
1200
1300
1000 3000 5000 7000 9000
Net wealth (Euro bn.)
Co
ns
um
pti
on
( E
uro
bn
.)
300
400
500
600
700
800
900
1000
1100
1200
1300
400 600 800 1000 1200 1400
Disposable income (Euro bn.)
Co
ns
um
pti
on
(E
uro
bn
.)
Consumption, wealth and disposable income:France, 1980-2002
Fig. 6.10
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Burda & Wyplosz MACROECONOMICS 4/e
Con
sum
ptio
n to
mor
row
0
With a credit constraint, the choice set is reduced.
D
C
B
A
R
Fig. 6.11
Consumption today
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Burda & Wyplosz MACROECONOMICS 4/e
GDP, domestic demand and the current account:Poland and East Germany
Fig. 6.12
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Burda & Wyplosz MACROECONOMICS 4/e
Marginal productivity of capital
Output
= 1+rslope
MPK
R
K
K
Marginal cost of capital1+r
Y=F K( )
K
K
Fig. 6.13
Output
Capital stock
Capital stock
Optimalcapital stock
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Burda & Wyplosz MACROECONOMICS 4/e
Technological progress makes more output possible with the same capital stock. Desired capital stock increases.
Marginal productivity of capital
OutputR
= 1+rslope
K
K
MPK´
New
1+r
Old
MPK
K
K
Fig. 6.14
Output
Capital stock
Capital stock
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Burda & Wyplosz MACROECONOMICS 4/e
The q-theory of investment
Tobin’s q
Inve
stm
ent
01
Fig. 6.15
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Burda & Wyplosz MACROECONOMICS 4/e
Investment and Tobin’s q:Inter-war Germany
Fig. 6.16(a)
0.0
20.0
40.0
60.0
80.0
100.0
120.0
140.0
1925:01 1927:01 1929:01 1931:01 1933:01 1935:01
Year
Ind
ex
(19
27
=1
00
)
Real stock prices Production of capital goods
© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4/e
Investment and Tobin’s q:Modern Germany
Fig. 6.16(b)
b) Tobin's q and Investment Spending in Germany, 1970-2002
0
50
100
150
200
250
300
350
400
450
500
1970 1974 1978 1982 1986 1990 1994 1998 2002
Year
Inve
stm
en
t (b
n e
uro
s)
0.000
0.500
1.000
1.500
2.000
2.500
3.000
Re
al s
tock
pri
ces
(19
95
=1
.00
)
Real investment Real stock prices
© Oxford University Press, 2005. All rights reserved.
Burda & Wyplosz MACROECONOMICS 4/e
Tobin’s q=1 in a world of no adjustment costs
(a)
Pre
sent
val
ue o
f M
PK
,co
st o
f ca
pita
l
1
I K( )
MPK1
MPK=Marginal return of new investment
C
If there were no costs of adjustment, the present value of the marginal cost of capital would be independent of the investment rate.
Note if there were no depreciation, the investment rate, I/K, = K/K, the rate of change of the capital stock.
Fig. 6.17
Investment rate (I/K)
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Burda & Wyplosz MACROECONOMICS 4/e
Tobin’s q when adjustment costs are significant
(a)
Pre
sent
val
ue o
f M
PK
,co
st o
f ca
pita
l
1
I K( )I K( )
1q
Marginal cost of investment
MPK1
C
However the faster we try to install new capital, the more it adds to the cost of that capital. “Haste makes waste.” Hence the upward slope of the marginal cost of investment with respect to the investment rate.
Fig. 6.17
Investment rate (I/K)
MPK=Marginal return of new investment
A
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Burda & Wyplosz MACROECONOMICS 4/e
Tobin’s q
(b)
Pre
sent
val
ue o
f M
PK
,co
st o
f ca
pita
l
A
1
1I K( )
1q
Marginal cost of investment
MPK1MPK2
2I K( )
2q B
With the investment rate corresponding to the rate at point A, in the following period there will be more capital and a lower MPK.
The investment rate next period will fall too (as will Tobin’s q), ultimately heading toward a value of unity and no more investment.
Fig. 6.17
Investment rate (I/K)
MPK=Marginal return of new investment
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