Unit 3- DI & Multipliers

Disposable Income (DI)

• Income after taxes or net income.
• DI = Gross Income - taxes
• 2 choices for households: consume or save
• Consumption: Household spending
• Amount of DI
• propensity to save
• Do households consume if DI = 0?
• Autonomous consumption
• Dissaving
• Saving: Household NOT spending
• Ability to save constrained by:
• Amount of disposable income
• Propensity to consume
• Do households save if DI = 0?
• NO

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 (MPC): Fraction of any change in disposable income that is consumed.
• Formula: Change in Consumption / Change in DI
• Marginal Propensity to Save (MPS): Fraction of any change in DI that's saved.
• Formula: Change in savings / Change in DI
• MPC + MPS = 1
• MPC = 1 - MPS
• MPS = 1 - MPC

Spending Multiplier Effect

• An initial change in spending causes a large change in aggregate spending or aggregate demand.
• Multiplier = Change in AD / Change in spending ( C, I, G, or X)
• Calculating Multiplier:
• 1 / 1-MPC or 1 / MPS
• + = increase in spending
• - = decrease in spending
• When the government taxes, the multiplier works in reverse.
• Because money is leaving circular flow.
• Tax multiplier
• -MPC / 1 - MPC
• -MPC / MPS
• If there's a tax cut, multiplier is positive.