Consumption and Savings

Disposable Income (DI)

• income after taxes or net income (spend or save)
• DI = Gross Income - Taxes
• 2 Choices :
• 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
• ability to consume is constrained by
• the amount of disposable income
• propensity to save
• the lower amount of money, more spending
• the higher the amount of money, more saving
• Do households consume if DI = 0 ?
• autonomous consumption
• dissavings
• APC = C / DI = % DI that is spent

Savings

• households NOT spending
• ability to save is constrained by
• the amount of disposable income
• propensity to consume
• Do households save if DI = 0 ?
• NO
• APS = S / DI = % DI that is not spent

APC and APS

 - APC is the average propensity to consume
 - APS is the 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
• ∆ C / ∆ DI
• % of every extra dollar earned that is spent
• Marginal Propensity to Save
• ∆ S / ∆ DI
• % of every extra dollar earned that is saved

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

Speding Multiplier Effect

• initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending or aggregate demand
• Multiplier = ∆ AD / ∆ in spending
• Multiplier = ∆ AD / ∆ C, Ig , G, Xn
• Why does this happen ?
• expenditures and income flow continuously, which sets off a spending increase in the economy

Calculating Spending Multiplier

• Multiplier = 1 / 1 - MPC or 1 / MPS
• multipliers are ( + ) when there is an increase in spending and ( - ) when there is a decrease

Calculating Tax Multiplier

• when the government taxes, the multiplier works in revers
• Why?
• because now the money is leaving the circular flow
• Tax Multiplier is always negative
• Multiplier = - MPC / 1 - MPC or - MPC / MPS
• if there is a tax cut, then the multiplier is ( + ), because there's now more money in the circular flow