AP_Krugman_Textbook

spending and current disposable income, the best estimate of ais $17,484 and of MPC

is 0.534. So the consumption function fitted to the data is:

c=$17,484+0.534×yd

That is, the data suggest a marginal propensity to consume of approximately 0.53.

This implies that the marginal propensity to save (MPS)—the amount of an additional

$1 of disposable income that is saved—is approximately 1 −0.53=0.47, and the multi-

plier is 1/(1 −MPC)=1/MPS=approximately 1/0.47 =2.13.

It’s important to realize that Figure 16.3 shows a microeconomicrelationship be-

tween the current disposable income of individual households and their spending on

goods and services. However, macroeconomists assume that a similar relationship

holdsfor the economy as a whole:that there is a relationship, called the aggregate con-

sumption function,between aggregate current disposable income and aggregate

consumer spending. We’ll assume that it has the same form as the household-level

consumption function:

(16-9) C=A+MPC×YD

Here,Cis aggregate consumer spending (called just “consumer spending”); YDis ag-

gregate current disposable income (called, for simplicity, just “disposable income”);

andAis aggregate autonomous consumer spending, the amount of consumer spend-

ing when YDequals zero. This is the relationship represented in Figure 16.4 by CF,anal-

ogous to cfin Figure 16.3.

164 section 4 National Income and Price Determination

Consumer

spending,C

Aggregate

consumption

function, CF 2

Aggregate

consumption

function, CF 1

Disposable income, YD

(a) An Upward Shift of the

Aggregate Consumption Function

(b) A Downward Shift of the

Aggregate Consumption Function

A 1

A 2

Consumer

spending,C

Aggregate

consumption

function, CF 1

Aggregate

consumption

function, CF 2

Disposable income, YD

A 2

A 1

figure 16.4 Shifts of the Aggregate Consumption Function

Panel (a) illustrates the effect of an increase in expected aggregate

future disposable income. Consumers will spend more at every

given level of aggregate current disposable income, YD. As a result,

the initial aggregate consumption function CF 1 , with aggregate au-

tonomous consumer spending A 1 , shifts up to a new position at CF 2

with aggregate autonomous consumer spending A 2. An increase in

aggregate wealth will also shift the aggregate consumption function

up. Panel (b), in contrast, illustrates the effect of a reduction in ex-

pected aggregate future disposable income. Consumers will spend

less at every given level of aggregate current disposable income,

YD. Consequently, the initial aggregate consumption function CF 1 ,

with aggregate autonomous consumer spending A 1 , shifts down to

a new position at CF 2 with aggregate autonomous consumer spend-

ingA 2. A reduction in aggregate wealth will have the same effect.

Theaggregate consumption functionis
the relationship for the economy as a whole
between aggregate current disposable
income and aggregate consumer spending.