Reference no: EM132460754

Americans spent all of their income gains and then some in July, keeping the economy humming in the second half of year.

Household spending-or what Americans paid for all goods and services, such as groceries and health care-rose 0.4% in July, the Commerce Department said Thursday. That marked another healthy gain after months of strong growth.

The increase partly reflects higher prices that businesses are charging for their items, itself a sign that demand in the economy is strong.

It also reflects that Americans have more money in their pockets, thanks to robust job growth, rising pay and a tax cut that took effect early this year. Household income-including what Americans earned from salaries and investments-rose 0.3% in July.

Also, the booming stock market and rising home values are raising Americans' wealth, which tends to encourage them to spend more and save less.

The fact that spending rose faster than income shows how confident Americans are in the economy these days. After accounting for inflation, consumer spending rose 2.8% in July, compared with the same month a year ago-an annual gain last exceeded in March 2017.

"It's encouraging to see that the American consumer continues to spend confidently and on a steady basis, with the streak in real spending gains extending to five months as of July," said Admir Kolaj, an economist at TD Economics, in a note to clients.

Consumer spending, which represents more than two-thirds of demand in the economy, was the biggest factor behind the economy's rapid 4.2% annual growth in the spring. Many economists expect 3% growth or more in the current quarter, largely because of expectations of household spending gains.

But economists don't expect the economy to sustain that pace in the long term. An aging population and meager gains in productivity are likely to hold back growth in coming years, they say.

For now, strong growth and rising inflation are likely to keep the Federal Reserve on track to raise interest rates twice more this year. The central bank is looking to raise rates steadily to keep the economy growing at a healthy pace while reducing the risk of it overheating.

Thursday's report showed the price index for personal-consumption expenditures-the Fed's preferred inflation measure-grew 0.1% in July from a month earlier. Core prices, which exclude volatile food and energy components, grew 0.2%.

While the monthly gains were modest, inflation over the past year has increased steadily to the Fed's target. Overall prices grew 2.3% in July, compared with a year earlier, while core prices were up 2%. Before this year, inflation had remained below the Fed's 2% annual target since 2012.

1. By what percentage did U.S. consumer spending rise in July from a year ago? When was the last month that consumer spending growth was so high?

2. What are two likely reasons for the surge in consumer spending last month? Is such a high growth rate likely to continue throughout the rest of 2018? Why or why not?

3. How did U.S. prices changes in July? How did household incomes change in July? Given this information, what most likely happened to the average U.S. household's marginal propensity to consume (mpc) in July?

4. Briefly explain how this change in mpc will impact U.S. economic output and price levels in the short run, using the aggregate supply/demand framework. Include a well-labeled AS-AD model figure. Post as an attachment. (NOTE: No AS-AD model, no points)