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This illustration is from Krugman's macroeconomics textbook, it's supposed to illustrate following situation (assuming that it happened for many people):

Conversely, suppose you have a good job but learn that the company is planning to downsize your division, raising the possibility that you may lose your job and have to take a lower-paying one somewhere else. Even though your disposable income hasn’t gone down yet, you might well cut back on spending even while still employed, to save for a rainy day.

In other words, the shift allegedly happened due to bad news about expected future disposable income.

enter image description here

By the way, here is the aggregate consumption function on which the plot above is based ("A" stands for the aggregate autonomous spendings by consumers, "YD" stands for aggregate disposable income of households): enter image description here

But I don't believe that the plot will shift like this in response to such bad news, it seems to contradict what I learned about microeconomic autonomous spending (I believe that the same must be true for aggregate autonomous spending). It's spending that you just WON'T reduce, they are too critical. You will tap into your savings, you will borrow or ask for charity, you will break the law, - but you absolutely WON'T reduce your autonomous spendings. You don't save money by decreasing your autonomous spending when you hear bad news, you just won't, it's your bare minimum that MUST be spent.

What I imagine will happen instead is that the marginal propensity to consume will decrease, increasing savings of people before the storm arrives, consequently changing the slope of the (aggregate) consumption function.

I understand that it's a textbook, so my reasoning must be wrong and the textbook must be right, but I fail to see mistakes in my reasoning.

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But I don't believe that the plot will shift like this in response to such bad news, it seems to contradict what I learned about microeconomic autonomous spending (I believe that the same must be true for aggregate autonomous spending). It's spending that you just WON'T reduce, they are too critical. You will tap into your savings, you will borrow or ask for charity, you will break the law, - but you absolutely WON'T reduce your autonomous spendings.

This is sort of correct, but not completely. In a narrow sense autonomous spending is a persons spending when her or his income is 0. As you mentioned consequently many textbooks use examples like people always must eat even if they dont earn any money. However, that suggest that autonomous spending is set at a bare subsistence level and that is not true.

It was already recognized by Adam Smith in his magnus opum the Wealth of Nations that what is and what isnt necessity, and thus something that would determine autonomous spending, is context dependent. As Adam Smith writes:

linen shirt … is, strictly speaking, not a necessary of life. Greeks and Romans lived, I suppose, very comfortably though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty which, it is presumed, nobody can well fall into without extreme bad conduct.

Hence, autonomous spending can change and it is dependent on the 'opulence' of society in general as well as of the individual. For example, if you would be a relatively rich commodity trader and you would be fired from your job (hence reducing your income to 0) you would not dis-save just to consume on subsistence level, but dis-save enough to maintain the minimum you would consider necessary for yourself. If you expect that long term you wont be part of the upper status class but will have to become middle class person you can move your autonomous spending to the level consistent with whats necessary for such person to live. Hence changes in expected income can move the whole consumption function up and down.

The slope of the consumption function (or the marginal propensity to consume) changes when person decides to consume smaller or larger fraction of their total income not just when consumption falls. For example, if your income is 1000 and your MPC is 0.6 you consume 600 and save 400. If your income is 500 you would consume 300 and save 200. In such example income changed but MPC remained the same.

MPC can change with income but empirically the poorer people have higher MPC than richer People. I dont have the Krugman's book but many textbooks include examples where the MPC is hold constant by assumption as a thought exercise and only changes to income are considered in similar fashion.

However, I also agree that the Krugman's wording is confusing as he talks about "saving for a rainy day", which can to many readers suggest MPC should decrease.

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  • $\begingroup$ But wouldn't MPC decrease if there is expected lower future income? Given that this future won't come too fast I would expect people to start saving more in desperate attempt to at the least somehow soften the blow. $\endgroup$ – user161005 May 15 at 15:59
  • $\begingroup$ @user161005 MPC can change as well but the changes in MPC are more complex. For example, as already mentioned in the answer empirically poorer people have higher MPC than rich. It is also possible that such expectation would create an intertemporal change where in current period MPC would decrease and increase in the next period. The two could also offset each other. Also it is always valid to perform a ceteris paribus thought experiment where you ask what would happen if only 1 thing changed and all else remained equal. So even if it would not hold in reality it’s useful to suppose it does. $\endgroup$ – 1muflon1 May 15 at 16:05
  • $\begingroup$ Also, do I understand correctly, that there are different bare minimums for different positions in social hierarchy due to upkeep costs of said positions? I mean, that there is certain fixed upkeep costs involved with keeping your current position in the society and if these costs are not paid, then you drastically increase (mabye to 1) chance that your social position will become lower. $\endgroup$ – user161005 May 15 at 16:11
  • $\begingroup$ @user161005 not sure if upkeep is the right word but you are correct what is a necessity is relative. In ancient Egypt it was normal for poor people to walk around naked. In some parts of the world it still is. But in the 1st world even a homeless person would not just walk around naked. The same holds for people in different positions for example a typical middle class person in the Netherlands where I live would be ashamed not to own a bike - which is the main mode of intracity transport here, in US you could consider a car to be middle class necessity. $\endgroup$ – 1muflon1 May 15 at 16:24
  • $\begingroup$ The reason why I hesitate to call it upkeep is that autonomous spending does not necessarily depends on what others think necessity is but what you think (although that is for sure shaped by a society). Simply if you think you cannot live without IPhone it would be a part of autonomous spending for you even if that would not be status symbol. $\endgroup$ – 1muflon1 May 15 at 16:27

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