Unit 3 consumption and saving notes

Consumption and Saving

Disposable income (DI)

                Income after taxes or net income

                DI= Gross income – taxes

2 choices

                With DI households can either

                                Consume (Spend money on goods and services)

                                Save (not spend money on goods and services)

Consumption

                Household spending

                Ability to consume is constrained by

                                The amount of disposable income

                                Propensity to save

                Do households consume if DI= 0?

                                Autonomous consumption

                                Dissaving

                APC = C/ DI = % that DI that is spent

Saving

                Household not spending

                Ability constrained by

                                Amount of DI

                                Propensity to consume

                Do households save if DI = 0?

                                NO

                APS = S/ DI = % DI that is not spent

APS and APC

                APC + APS = 1

1-APS = APC

1-APC= APS

APC > 1 Dissaving

-APS Dissaving

Marginal Propensity to Consume

                Change in C/ Change in DI

                % of every extra dollar earned that is spent

Marginal Propensity to save

                Change in S / Change in DI

                % of every extra dollar earned that is saved

                MPC +MPS = 1

                1-MPS = MPC

                1-MPC = MPS

Spending Multiplier effect

                Initial change in spending (C, IG, G, and 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, or XN

                Multiplier = 1/ (1-MPC) or 1/MPS

                If multiplier is (+) then increase in spending, if (–) then decrease in spending

                Why does it happen?

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

Tax multiplier

                When the government taxes the multiplier works in reverse because money leaving the circular flow

                Tax multiplier = -MPC/ (1-MPC) or –MPC / MPS it is always negative

                If there is a tax cut then the multiplier is + because more money introduced in the circular flow.