 So how do we know if our economy is booming or crashing? The income expenditure model, the Keynesian model of the economy, says a lot will depend on aggregate demand. That is how much different groups in society want to buy. If a lot of people and a lot of businesses and the government is spending a lot of money, the economy will be booming. If they're not spending much money, if they're not engaging in much demand, the economy will be shrinking. Right now we're in a big serious recession and that's because under this model, it's because people aren't spending enough. Now we need to build up this model little by little. So Keynes started first with a discussion of consumption. GDP equals consumption plus investment plus government expenditure plus exports minus imports. But now we're going to simplify this and we're just going to talk about consumption. What determines how much people will consume? Well, as economists, we always come up with a simple theory and our simple theory says this. Think about it. When you have more income, you're going to consume more. How much are you going to consume though if you have zero income? Are you not going to consume anything? Are you going to just starve? Well, let's hope not. Even if you don't have any income, you're still going to consume some. How? Say by borrowing or perhaps by running down some savings, money that you've saved from before. So even if income is zero, you'll consume some. And that's a very simple theory but it actually works. It fits the data and it's the underlying theory behind the consumption function. So we're going to say the consumption depends on disposable income. Disposable income. That's the amount of income that you have after you've paid your taxes. Disposable income. But remember what I said. Even if you don't have any income, even if this is zero, you're still going to consume something. So we're going to call that A. Where A is autonomous consumption. Now here's the trick. If your income goes up by $1, are you going to spend that whole dollar or possibly you're going to save some of that for a rainy day? Well what we've discovered and what Cain's thought is that most people save some of that income for a rainy day so they don't consume every additional dollar in more consumption. So economists have decided to define something called the marginal propensity to consume. Or MPC. So let's say out of every dollar you just consume 50 cents and you save 50 cents. That means you're only consuming a half of that dollar. So that means the marginal propensity to consume is one half. So here we have our consumption theory. Consumption equals autonomous consumption which you will spend no matter how much income you have plus say a half of every additional dollar you have in disposable income. Now the next thing we want to do is put this on a graph. So I'm going to show you how we can graph this relationship. We're going to be using a lot of these graphs in developing our income expenditure model. So we're going to put spending up here and we're going to put disposable income on the horizontal axis. And all this shows is that when disposable income goes up, consumer spending goes up. So this has a positive relationship. We know it doesn't start at zero because even if you have zero income you're still going to spend. How much will you spend? You'll spend, A, say, $100. And as disposable income goes up, your consumption goes up. This we call voila, the consumption function. See you next time.