Unit 3 Savings and Consumption

Disposable Income

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

2 choices
- With DI households can either
  □consume
  □save

 

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
   □dissaving

APC = C/DI = percent DI that is spent

 

Saving

- Household NOT spending
- the ability to save is constrained by
   □ the amount of disposable income
   □ the propensity to consume
-Do households save if DI = 0
   □No
-APS = S/DI = percent DI that is not spent

APC AND APS
- APC + APS = 1
- 1- APC = APS
- 1- APS = APC
- APC >  1 DISSAVING

 

MPC AND MPS

- Marginal propensity to consume
  ■ C OVER DI
  ■ percent of every extra dollar earned that is spent
- Marginal prosperity to save
  ■S over DO
  ■ percent of every extra dollar earned that is saved

MPC PLUS MPS = 1
1- MPC = MPS
1- MPS = MPC

 

The spending multiplier effect

-the initial change in spending causes a larger cjange in Aggregate spending or aggregate demand
- Multiplier = change in AD over change in spending

 

The spending multiplier effect

Why it happens? Expenditures and income flow continuously which sets off a spending

Calculating the spending multiplier
Multiplier is 1 over 1-MPC OR 1 OVER MPS

Multipliers are positive when there is an increase in spending and negative when there is a decrease

Calculating the tax multiplier

- when the government taxes, the multiplier works in reverse
-Why?  Because now money is leaving the circular flow
- Tax Multiplier = - MPC OVER 1-MPC OR -MPC over MPS
- If there is a tax cut then the multiplier is positive because there is now more money in the circular flow.