Unit 3 - Consumption and Saving

Disposable Income

• Income after taxes or net income
• DI = Gross Income - Taxes

2 choices

With disposable income, household can either

- Consume (spend money on goods, and services )

- Save (not spend money on goods & services)

Consumption

• Household spending 
• The ability to consume is constrained by the amount of disposable income
• The propensity to save

Do households consume if DI = 0 ?

-Autonomous consumption

-Dis-saving

• APC = C/ DI =  % DI that's spent 

Saving

• House hold not spending
• The ability to save is constrained by the amount of disposable income
• The propensity to consume

Do house holds save if DI = 0 ?

- No

• APS = S/DI= % DI that is not spent

APC and APS

• APC+APS = 1
• 1-APC = APS
• 1-APS =APC
• APC > 1.: Dis-saving
• APS.: Dis-saving

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MPS and MPC

-Marginal Propensity to consume (MPC)

• MPC = change in C/ change in DI

-% of every extra dollar earned that is spent

 

-Marginal Propensity to save (MPS)

• MPS = change in S/ change in DI

-% of every extra dollar earned that is saved

 

- MPC + MPS = 1

-1-MPC=MPS

-1-MPS=MPC

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Spending Multiplier Effect

An inital change in spending (C,Ig,G,Xn) causes a larger change in Aggregate Spending or Aggregate demand

• Multiplier =change in AD/ hange in spending (C,Ig,G,Xn)

Why does this happen? 

Expenditures and income flow continuously which sets off a spending increase in the economy 

 

Calculating the Spending Multiplier

Can be calculated from MPC or MPS

• Multiplier = 1/1 -MPC or 1/MPS

*Multipliers are (+) when there is an increase in spending and (-) when there is a decrease in spending

Calculating Tax Multiplier

When the government taxes the multiplier it works inverse because how money is leaving the circular flow
Tax Multiplier (Always going to be negative*)

• Multiplier = MPC/1-MPS or -MPC/MPS

*If there is a tax-cut, then the multiplier is +, because there is now more money in the circular flow