consumption and savings

Disposable Income (DI) - amount of money after taxes/net incomes.

•  DI = gross income -taxes.
•  2 Choices : Spending/Consumption and Saving.

Consumption - household spending.

• The ability to consume is constrained by:

                 -the amount of DI.

               -the propensity to save.

• Do household consume if DI = 0?

             -autonomous consumption

              -dis-saving

• APC = (C / DI) = DI that is spent.

Saving - household not spending.

• The ability to save is constrained by:

             -the amount of DI.

             -the propensity to consume.

• Do household consume if DI = 0? No

• APS = (S / DI) = DI that is not spent.

APS & APC 

•  APS + APC = 1
•  1 - APS = APC 
•  1 - APC = APS 
•  APC > 1 .: Dissaving
• APS .: Dissaving

MPC & MPS

• Marginal propensity to consume.

             -change in C / change in DI

               -% of every extra dollars earned that is spent.

• Marginal propensity to save.

              -change in in S / change in in DI

               -% of every extra dollar earned that is saved.

• MPC + MPS = 1
• 1- MPC = MPS
• 1- MPS = MPC

Determinants of Consumption and Saving

•   wealth
•   expectations
•   household debts
•  taxes

Spending multiplier effect - an initial change in spending (C, Ig, G, Xn) causes a larger change in AD.

• Multiplier: change in AD/change in spending.
• Multiplier: change in AD/change in C, Xn, G, Ig.

  Why does this happen?
    . expenditures and income glow continuously which sets off a spending increase in the economy

Calculating the spending multiplier

•  Multiplier: 1 / 1-MPC
•  Multiplier: 1 / MPS

    . multipliers are (+) when there is an increase in spending & (-) when there is a decrease

Calculating the tax multiplier

•   -MPC / 1 - MPC
•   -MPC / MPS
•  if there is a tax cut then the multiplier is +, because now there is more money in the circular flow.