Unit 3: Consumption

Disposable Income (DI)
  • Income after taxes or net income (take home)
  • What you have left over after you've payed all your bills
2 Choices
  • 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
    • The amount of disposable income 
    • The propensity to save
  • Do households consume is DI = 0??
    • Autonomous consumption
    • Dissaving
Saving
  • Household NOT spending
  • The ability to save is constrained by
    • The amount of disposable income
    • The  propensity to consume
  • Do households save if DI = 0?
    • NO
APC % APS (average propensity to consume and average propensity to save)
  • APC + APS = 1
  • 1 - APS = APC
  • 1 - APC = APS
  • APC > 1 is Dissaving
  • -APS is Dissaving
MPC & MPS (Marginal propensity to consume and marginal propensity to save)

Marginal propensity to Consume
  • The fraction of any change in disposable income that is consumed
  •  △  in consumption / △ in DI
  • % of every extra dollar earned that is spend
Marginal propensity to Save
  • The fraction of any change in disposable income that is saved 
  •   △ in saving /   △ in DI
  • % of every dollar earned that is saved
MPC + MPS = 1
1 - MPC = MPS
1 - MPS = MPC

Spending Multiplier Effect

  • An initial change in spending (C, Ig, G, Xn) cases a larger change in aggregate spending, or Aggregate Demand (AD).
  • Multiplier =  △ in AD /   △ in Spending 
    • Change in spending = C, Ig, G, or Xn
  • Why does this happen??
    • Expenditures and income flow continuously which set off a spending increase in the economy. 
Calculating the spending multiplier 
  • Spending Multiplier can be calculated from the MPS or the MPS.
    • Multiplier = 1 / 1-MPC 
    • = 1 / MPS
    • Multipliers are (+ )when there is an increase in spending and (-) when there is a decrease
Calculating the Tax Multiplier
  • When the gov. taxes, the multiplier works in reverse
  • Why??
    • Because now money is leaving the circular flow
  • Tax Multiplier (note: its negative )
    • Tax Multiplier = -MPC / 1-MPC 
    • = -MPC / MPS
  • If there is a tax CUT, then the multiplier is  + because there is now more money in the circular flow

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