Consumption

We all like to spend money, and in so doing we are consuming goods and services and creating demand in the economy. This generates output and employment. Consumption in macroeconomics measures the total planned level of demand in the economy by households for final goods and services. Consumption spending is the largest element of the aggregate demand, and so changes in household’s spending can have a major impact on the economy. Economists are naturally interested in what determines the total level of consumption in the economy because this is such an important element of the aggregate demand and therefore has a big influence on how well an economy is doing.

The size of the marginal propensity to consume (MPC) depends on the following.

· Interest rates. If interest rates are high then consumers may be more willing to save to earn higher returns and less willing to spend; this would reduce the MPC.

· Expectations of future price increases. If households expect that prices will increase in the future then they are likely to buy more now before the prices rise; this increases the MPC.

· Expectations of the future state of the economy. If households predict that the economy will go into a recession and that they may lose their jobs then they may save now to build up a reserve fund. In this case the marginal propensity to save may increase and the marginal propensity to consume may fall.

· Income levels. As income levels increase the MPC domestically is likely to fall. Consumers will already have bought many of the items they need and therefore will tend to save more out of the extra income. At low incomes, by comparison, any income earned is more likely to be spent.

· The availability and quality of domestic goods compared to foreign goods. This will influence the level of spending on UK products as opposed to imports.

An increase in the marginal propensity to consume will lead to more money being spent out of each extra pound and will change the slope of the consumption function.

I. Restore the word order in the questions and answer them:

1) measure, in macroeconomics, does, a consumption, what?

2) a major impact, have, can, on the economy, what?

3) the largest element, the aggregate demand, is, of, what?

4) the level of consumption, in, are, aren’t, economists, interested, they?

5) the consumption function, will, of, the slope, change, what?

II. Complete the following statements:

1) If interest rates are high ….

2) If households expect that prices will increase in the future ….

3) If households predict that the economy will go into a recession ….

4) If an income levels fall ….

2) Translate the text «Investment»

Investment occurs when firms make a decision to allocate resources into projects that will generate future returns, investing in a new machine or a new information technology system. Investment involves sacrificing existing, present consumption for future expected benefits.

Investment may be in the following.

· Fixed capital. This involves the purchase of assets that are expected to be used for a long period, factories and production equipment.

· Working capital. These are short-term assets that will be used up in the production process; for example, stocks and materials.

The types of investment include the following.

· Gross investment. The measures the total investment in a economy in a period.

· Depreciation investment. This is investment undertaken to replace equipment or machinery that has worn out.Depreciation investment simply maintains the level and quality of the capital stock.

· New investment. This is new investment that increases the capital stock in the economy.

Therefore we have:

Gross investment= New investment + Depreciation investment.

The amount of investment in an economy will depend on the following.

· The initial cost of projects. Some projects may be attractive in terms of the possible rewards that they offer, but may not be affordable at the present time if firms do not have or cannot raise the necessary finance. Therefore the availability and cost of finance is an important issue. High interest rates will make it more expensive to borrow and are likely to reduce the level of investment.

· The expected returns from the investment. What are the expected costs and revenues from the project and, therefore, what profits does the firm expect to be earned and over what period? These estimates of revenues and costs are, of course, only a forecast of the future net inflows. Investment decisions inevitably have an element of risk and uncertainty. An investment into an oil project, for example, involves estimates of what the world oil price will be many years into the future-this involves a high degree of risk in terms of the accuracy of the forecast. However, the likely returns will depend on firms views about the likely levels of sales, which is likely to be linked to economic growth and also the likely inflation rates.

· The alternatives available. A decision to invest in one projects means that resourced are being allocated to this area and away from something else. A decision is therefore being made about the best way to use resources and this involves an opportunity cost. If, for example, the returns available in other countries or in financial savings such as shares are high then this is likely to reduce the level of investment in the UK.

· Risk and culture. Any investment project will involve risk because the outcomes are not certain. Different managers are organizations may have different perceptions of the risk of any particular project and will have different attitudes to taking risks. This may affect their willingness to pursue a particular investment. If a country had a culture which was risk-taking then this might affect the level of investment in one country compared to another. National culture can also be important in other ways. In the past Japanese and German firms have tended to be more long-termist than UK firms; this means that they were wiling to wait longer for the eventual rewards. This was partly because their investors tended to be linked to the firm in some way (such as being their suppliers) and so were wiling to wait for the long-term benefits in which they would share. In the UK investors do not tend to be directly linked to the business and look for short-term rewards. This has tended to reduce the number of projects that UK firms might invest in compared to Japanese firms.

· Non-financial factors. When considering an investment a firm may be interested in the expected profits, but it may also take into account non-financial factors. What will the investment do to the brand image? How will stakeholders in the firm react to the investment? Will it fit with any proposed policy on issues such as corporate social responsibility? Does it fit with the corporate strategy? Investing in a new product area may itself appear profitable, for example, but may not fit with a corporate strategy that intends to focus on existing business areas. In recent years, for example, firms have generally been more concerned with the environmental impact of their activities, and this has diverted investment away from some projects that are perceived to be environmentally unfriendly. On a national scale, firms may be concerned about factors such as political stability.

· Government policy. Changes to the tax system can provide incentives for firms to invest. For example, tax credits may enable firms to reduce their tax bill if they invest more in research and development.

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