Personal Finance and Macroeconomics
Lesson 3: Personal Savings and Macroeconomic Factors
1. Personal Saving, Disposable Income, and Breakeven Point
- Personal saving is the portion of disposable income not spent on consumption. It’s what remains after covering basic needs and discretionary expenses.
- Disposable income (DI) is the income remaining after taxes are deducted, available for spending and saving. DI = Income – Taxes
- Breakeven point is when income equals expenditures, preventing savings. Any additional income must be saved or spent.
2. Determinants of Consumption
Consumption depends on:
- Current disposable income: Higher disposable income generally leads to increased consumption.
- Permanent disposable income: Consumption is often based on long-term income expectations (Friedman’s Permanent Income Hypothesis).
- Net wealth: Wealthier individuals tend to spend more.
- Interest rate: Higher rates may discourage consumption as saving becomes more attractive, and borrowing costs rise.
- Human wealth: Expected future income from labor/skills influences current consumption.
- Non-human wealth: Financial assets (stocks, bonds, property) positively influence consumption.
- Life cycle: Individuals plan consumption/saving over their lifetime (Life-Cycle Hypothesis). Young people may borrow, while older individuals save for retirement.
3. Determinants of Investment
Investment decisions are influenced by:
- Interest rate: Lower rates reduce borrowing costs, encouraging investment.
- Revenue and profits: Firms invest anticipating future profits. Higher current profits provide internal funds.
- Costs: Production costs (wages, energy, materials) affect investment decisions.
Lesson 4: Fiscal Policy
1. Components of Fiscal Policy
- Taxes: Government revenue; higher taxes can reduce disposable income, impacting consumption and investment.
- Government expenditure: Spending on goods/services (infrastructure, education, defense); directly increases aggregate demand.
2. Budgetary Concepts
- Budget deficit: Expenditures exceed revenues, often financed by borrowing.
- Budget surplus: Revenues exceed expenditures, enabling debt reduction.
- Debt: Accumulated past deficits; high levels may increase borrowing costs.
- Risk premium: Higher government debt may increase risk premiums as investors demand higher returns.
3. Types of Fiscal Policy
- Expansionary: Increased spending or decreased taxes to stimulate the economy during recessions.
- Contractionary: Decreased spending or increased taxes to slow the economy and control inflation.
4. Fiscal Policy Approaches
- Discretionary: Deliberate changes in taxes or spending (e.g., stimulus package).
- Non-discretionary: Automatic changes without direct intervention (e.g., unemployment benefits).
Lesson 5: Economic Equilibrium and the Multiplier Effect
1. Savings-Investment Imbalance
Consequences:
- Inflation/deflation: Excess investment can cause inflation; excess savings can lead to deflation.
- Unemployment: High savings can decrease demand, leading to job losses.
- Interest rate changes: Imbalances force interest rate adjustments.
- Slower economic growth: Persistent imbalance hinders long-term prosperity.
2. Production-Expenditure Imbalance
Consequences:
- Over/underproduction: Expenditure below production leads to unsold inventory.
- Unemployment: Overproduction causes cutbacks and layoffs.
- Price adjustments: Imbalances affect price levels.
- Macroeconomic instability: Persistent imbalances create volatility.
3. The Multiplier Effect
- Amplification: Initial spending changes lead to larger overall economic changes.
- Sequential process: Works through successive spending rounds.
- MPC dependence: Higher marginal propensity to consume (MPC) increases the effect.
- Time lag: Full effect takes time.
- Cumulative: Accumulates as spending flows through the economy.
4. Factors Decreasing the Multiplier Effect
- High savings rate: Reduced spending diminishes the effect.
- Imports: Spending on foreign goods leaks from the domestic economy.
- Taxes: Reduced disposable income dampens the effect.
- Debt repayment: Using extra income for debt repayment doesn’t stimulate consumption.
5. Government and the Multiplier: Crowding-Out Effect
- Crowding out: Government borrowing increases interest rates, potentially offsetting the impact of government spending.
6. Fiscal Policy Implementation Problems
- Time lags: Recognition, decision, and implementation lags delay effects.
- Ricardian equivalence: Consumers may increase savings in anticipation of future tax increases to repay government debt, offsetting stimulus.