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Mps economics2/18/2023 ![]() ![]() Let’s explore their meanings in economics. In the above equation, “a” is the intercept of the line and b is the slope. To simplify our discussion, we will assume that Consumption is a linear function of Disposable Income, just as it was graphically shown above. Disposable income is that portion of your income that you have control over after you have paid your taxes. The Consumption Function shows the relationship between consumption and disposable income. The graph below demonstrates the relationship between consumption and savings: In economics we call this “dissavings.” Point E is called the breakeven point because it is the point where there are no savings but there are also no dissavings. How can savings be negative? If you thought of borrowing, you are right. At income levels to the right of point E (like Io), savings is positive because consumption is below income, and at income levels to the left of point E (like I'), savings is negative because consumption is above income. At that point, labeled E in our graph, savings is equal to zero. Notice the use of the 45˚ degree line to illustrate the point at which income is equal to consumption. Consider the graph below, which shows Consumption as a positive function of Income: If income goes up then consumption will go up and savings will go up. In this simple model, it is easy to see the relationship between income, consumption, and savings. ![]() In the simplest model we can consider, we will assume that people do one of two things with their income: they either consume it or they save it. Because government spending is determined by a political process and is not dependent on fundamental economic variables, we will focus in this lesson on an explanation of the determinants of consumption and investment. The components of aggregate expenditures in a closed economy are Consumption, Investment, and Government Spending. Before developing the Keynesian Aggregate Expenditures model, we must understand the basic macroeconomic relationships that are the components of that model.
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