Macroeconomics Unit III: Savings and Consumption

SAVINGS & CONSUMPTION

Two choices

• with disposable income, households can either...

1. Consume (spend money on goods and services)
2. Save (not spend money on goods and services)

Disposable Income 

• income after taxes or net income
• DI = (gross income- taxes)

Consumption

• household spending

The ability to consume is constrained by

• the amount of disposable income
• propensity to save

Do households consume if DI = 0?

• autonomous consumption
• dis-saving

APC 

• APC = (C/DI) = % DI that is spent

Savings

• households not saving

The ability to save is constrained by

• amount of disposable income
• propensity to consume

Do households save if DI= 0?

• no

APC & APS Equations

• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1 dis-saving 
• (- APS) dis-saving 

MPC & MPS

Marginal Propensity to Consume

• Δ C/ Δ DI
• percent of every extra dollar earned that is spent

Marginal Propensity to Save

• Δ S/ Δ DI
• percent of every extra dollar earned that is saved

MPC & MPS Equations

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

Multipliers

Spending Multiplier Effect

• an initial change in spending (C, Ig, G, Xn) causes a larger change in aggregate spending or aggregate demand
• Spending Multiplier = ( Δ in AD) / (Δ in spending C, Ig, G, Xn)

Why does the Spending Multiplier Effect happen?

• expenditures and income flow continuously which sets off a spending increase in the economy 
• can be calculated from MPC or MPS 
• (1)/ (1 - MPC) or (1)/ (MPS)
• Spending Multiplier is positive when there is an increase in spending and negative when there is a decrease

Tax Multiplier

• when government taxes, the multiplier works in reverse because now money is leaving the circular flow
• is negative
• ( - MPC)/ (1 - MPC) or ( - MPC)/ ( MPS)
• tax cut = positive tax multiplier because there is more money in the circular flow