Unit 3 Notes - Consumption & Saving

·      Disposable Income (DI) – Income after taxes or net income

·      DI = Gross Income (Total) – Taxes

·      2 Choices – With disposable income, households can either –

1.     Consume (Spend money on goods and services)

2.     Save (Not spend money on goods and services)

·      Consumption

-       Household Spending

-       The ability to consume is constrained by

1.     The amount of disposable income

2.     The propensity to save

·      Do households consume if DI = 0? – No, Autonomous Consumption, Dissaving

·      Saving

-       Household NOT Spending

-       The ability to save is constrained by –

1.     The amount of disposable income

2.     The propensity to consume

·      Do households save if DI = 0? – NO

·      APC + APS

-       APC + APS = 1

-       1 – APC = APS

-       1 – APS = APC

-       APC greater than 1 = Dissaving

-       -APS = Dissaving

·      MPC + MPS

-       Marginal Propensity to Consume

1.     Change in C/Change in DI

2.     % Of every extra dollar earned that is spent

-       Marginal Propensity to Save

1.     Change in S/Change in DI

2.     % Of every extra dollar earned that is save

-       MPC + MPS = 1

-       1 – MPC = MPS

-       1 – MPS = MPC

·      The Spending Multiplier Effect

-       An initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending, or aggregate demand (AD)

-       Multiplier = Change in AD/Change in Spending

-       Multiplier = Change in AD/Change in 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

-       The Spending Multiplier can be calculated from the MPC or the MPS

-       Multiplier = 1/1-MPC  or  1/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 because now money is leaving the circular flow

-       Tax Multiplier (Always Negative) –MPC/1-MPC or –MPC/MPS

-       If there is a tax CUT, then the multiplier is positive, because there is now more money in the circular flow