Unit Three: Consumption and Saving

Consumption and Saving

Notes from 2/25/16

Disposable Income: Income after taxes or net income

       -DI = Gross Income - Taxes

2 Choices

       -With DI, households can either:

         +Consume

         +Spend

         +Cannot do both at 100%

Consumption

-Household spending

-Ability to consume is constrained by:

   +The amount of disposable income

   +The propensity to save

-Do households consume if DI=0?

    +Autonomous Consumption (automatically comes out of paycheck)

    +Dissaving

Saving

-Household NOT spending

-The ability to save is constrained by:

   +The amount of disposable income

   +The propensity to consume

-Do households save is DI=?

    +NOPE!

APC and APS

-Average Propensity to Consume and Average Propensity to Save

APC + APS = 1

1 - APC = APS
1 - APS = APC
APC > 1 = Dissaving
-APS = Dissaving

MPC and MPS

-Marginal Propensity to Consume and Marginal Propensity to Save 

• MPC = Change in Consumption / Change in DI
• ∆ C / ∆ DI
• MPS: Fraction of any change in disposable income that is saved
• ∆S / ∆ DI

Marginal Propensities

MPC + MPS = 1 
1 - MPS = MPC
1 - MPC = MPS

Spending Multiplier Effect

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

Multiplier = ∆AD / ∆C, G, Ig, Xn

Calculating Spending Multiplier

1 / 1 - MPS OR 1 / MPC

Multipliers are POSITIVE when there is an increase in spending and NEGATIVE when there is a decrease in spending. 

Calculating Tax Multiplier

-MPC / 1 - MPC OR -MPC / MPS

-When government taxes, multiplier works in reverse

-Money is leaving the circular flow

-Always NEGATIVE

-If there is a tax cut, then multiplier is POSITIVE

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