Unit 3- Consumption and Saving

Disposable Income (DI): Income after taxes or net income.

With disposable income, households can either: 

• Consume (spend money on goods and services) 
• Save(not spend money on goods and services) 

Consumption (C) is household spending. Households consume if DI = 0 through autonomous consumption and dissaving. The ability to consume is constrained by:

• The amount of DI
• The propensity to save

Saving (S) is when the household is NOT spending. Households do NOT save if DI = 0. The ability to save is constrained by:

• The amount of DI
• The propensity to consume

Average propensity to consume (APC) and average propensity to save (APS) formulas:

• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1 (dissaving)
• -APS (dissaving)

Marginal Propensity to Consume (MPC) 

• It's the percentage of every extra dollar that is spent
• The fraction of any change in disposable income that is consumed
• MPC = Change in consumption/change in disposable income= ΔC/ΔDI
• MPC = 1- MPS

Marginal Propensity to Save (MPS) 

• It's the percentage of every extra dollar that is saved
• The fraction of any change in disposable income that is saved
• MPS = Change in savings/change in disposable income = ΔS/ΔDI
• MPS = 1- MPC

The Spending Multiplier Effect 

• An initial change in spending (C, I, G, and/or X) causes a larger change in aggregate spending, or aggregate demand (AD). 
• This happens because expenditures and income flow continuously which sets off a spending increase in the economy. 
• Multiplier = (Change in AD)/(Change in spending) = ΔAD/ΔC, ΔI, ΔG, or ΔX

Calculating the Spending Multiplier

• Can be calculated from the MPC or the MPS. 
• Multipliers are positive when there is an increase in spending and negative when there is a decrease.
• Spending Multiplier = (1)/(1 - MPC) OR (1)/(MPS)

Calculating the Tax Multiplier

• When the government taxes, the multiplier works in reverse because now money is leaving the circular flow.
• If there is a tax cut, then the multiplier is positive, because there is now more money in the circular flow. 
• Tax Multiplier (note:it's negative)= (-MPC)/(1 - MPC) = (-MPC)/(MPS)