Unit 3: Topic 5- Consumption and Savings

Disposable Income (DI)

• Money (Income) after taxes or net income
• Can actually spend
• DI = Gross Income- - Taxes
• Gross means TOTAL

2 Choices When It Comes To DI

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 

• The amount of disposable income
• the propensity to save

Do household consume if 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 AND APS

Average Propensity to Consume (APC)

Average Propensity to Save (APS)

• APC + APS = 1
• 1 - APC = APS 
• 1 - APS = APC 
• APC > 1 = DISSAVING
• -APC = DISSAVING

Marginal Propensity to Consume AND Marginal Propensity to Consume

Marginal Propensity to Consume (MPC)
🔺C/🔺DI
(C- Consumption)
% of every extrar dollar earned that is spent
Marginal Propensity to Save (MPS)
🔺S/🔺DI
(S- Saving)
% of every extra dollar earned that is saved
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 = 🔺 in AD/ 🔺 in spending
• Multiplier = 🔺 in AD / 🔺 (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 (+) when there is an increase in spending and (-) when there is a decrease in spending.

Calculating the Tax Multiplier 

• When the government taxes, the multiplier works in reverse.
• Why? Because now money is leaving the circular flow
• Always NEGATIVE
• Tax Multiplier (note it is negative) = -MPC/ 1- MPC or -MPC / MPS
• If there is a tax - cut, then the multiplier is + because there is now more money in the circular flow.