Changes in Consumption and Income

We can examine the changes in consumption and income that arose after the tax changes and see whether these changes are consistent with the model. There is a critical difference between our theory and reality, however. When we discussed the effects of a tax cut using our theory, we implicitly held everything else constant. We presumed that there was a change in taxes and no change in any other variable. For example, we assumed that government spending, investment spending, and net exports all did not change. In fact, other economic variables were changing at the same time that the new tax policy went into effect; these changes could also have affected consumption and disposable income. Looking at particular tax experiments is a messy business. Taxes were cut in February 1964, and (real) disposable income increased by $430 billion, a much larger increase than in previous time periods. Consumption expenditures increased considerably during this period. Table 12.4 “Consumption and Income in the 1960s (Seasonally Adjusted, Annual Rates)” summarizes the behavior of GDP, disposable income, consumption, and the average propensity to consume over the 1960–68 period. Remember that these are real variables, measured in year 2000 dollars. The average propensity to consume is calculated as consumption divided by disposable income, and the marginal propensity to consume is calculated as the change in consumption divided by the change in disposable income. Table 12.4 Consumption and Income in the 1960s (Seasonally Adjusted, Annual Rates)

Year Real GDP ($)

Disposable Income ($)

Consumption ($)

APC MPC

1960 2,501.8 1,759.7 1,597.4 0.91 —

1961 2,560.0 1,819.2 1,630.3 0.90 0.55

1962 2,715.2 1,908.2 1,711.1 0.90 0.91

1963 2,834.0 1,979.1 1,781.6 0.90 0.99

1964 2,998.6 2,122.8 1,888.4 0.89 0.74

1965 3,191.1 2,253.3 2,007.7 0.89 0.96

1966 2,399.1 2,371.9 2,121.8 0.89 0.96

1967 3,484.6 2,475.9 2,185.0 0.88 0.61

1968 3,652.7 2,588.0 2,310.5 0.89 1.11

APC, average propensity to consume; MPC, marginal propensity to consume.