Disposable Income
· Income after taxes or net income
· DI = Gross income – Taxes
· Two choices:
o
With
disposable income, households can either
§
Consume
(spend money on goods and services)
§
Save
(not spend money on goods and services)
Consumption:
· Household spending
· The ability to consume is constrained
by:
o
The
amount of disposable income
o
The
propensity to save
· Do households consume if DI = 0?
o
Autonomous
consumption
o
Dissaving
· Average Propensity to Consume
o
APC
= C/Di = % of DI that is spend
Saving
· Household not spending
o
The
ability to save is constrained by:
§ The amount of disposable income
§ The propensity to consume
o
Do
households save if DI = 0?
§ No
o
Average
Propensity to Save
§ APS = S/DI = % of DI that is not spent
APC and APS:
· APC + APS = 1
· 1 - APC = APS
· 1 - APS = AP
· APC > 1 = Dissaving
· -APS = Dissaving
Marginal Propensity
to Consume
· MPC = ΔC/ΔDI
· % of
every dollar earned that is spent
Marginal Propensity to Save
· MPS = ΔS/ΔDI
· % of every extra
dollar earned that is saved
· MPC + MPS = 1
· 1 - MPC = MPS
· 1 - MPS = MPC
The
Spending Multiplier Effect:
· An initial change in
spending causes a larger change in aggregate spending or aggregate demand
· Multiplier = Change in AD (ΔC, Ig, G, Xn) / Change in spending
· Why does this happen?
o
Expenditures
and income flow continuously which sets off a spending increase in the
economy
Calculating the
Spending Multiplier:
· Multiplier = 1/1-MPC or 1/MPS
o
Multiplier are positive when there is an increase in
spending and negative when there is a decrease
o
Spending multiplier can be calculated from the MPC
or MPS
Calculating
the Tax Multiplier:
· The government taxes the multiplier works in reverse.
· Why?
o
Because now money is leaving the circular flow
· Tax Multiplier (note: it is negative)
o
-MPC/ 1-MPC or –MPC/MPS
· If tax cut, multiplier is positive because now money is in the circular
flow.
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