Unit 3 Consumption and Saving

• Disposable Income (DI): Income after taxes, or net income
• DI= Gross Income - Taxes
• 2 choices: Consume or Save their DI (never at the same time)
• Consumption: Household spending
• the ability to consume is constrained by:
• amount of DI
• the propensity to save
• Do households consume if DI=0?
• autonomous consumption
• dissaving
• Saving: Household NOT spending
• the ability to save is constrained by:
• amount of DI
• the propensity to consume
• Do households save if DI=0? NO
• APC(Avg Propensity to Consume) & APS(Avg Propensity to Save)
• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1: Dissaving
• -APS: Dissaving
• MPC(Marginal Propensity to Consume): fraction of any change in DI that's consumed
• MPC= ΔC
            -------
              ΔDI
• MPS(Marginal Propensity to Save): fraction of any change in DI that's saved
• MPS= ΔS
          -------
           ΔDI
• MPC + MPS = 1
• MPC = 1 - MPS
• MPS = 1-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)

                         EQUATION: Change in AD
                                              -----------------------
                                              Change in spending

                         Multiplier=       Δ  AD
                                               ---------------
                                             Δ C, Ig, G, or Xn             

Tax Multiplier

• when the government taxes, the multiplier works in reverse b/c money is now leaving the circular flow
• Tax Multiplier (negative)
•         -MPC                     -MPC
        ------------     OR      ----------
         1- MPC                    MPS
• If there's a tax-cut, the multiplier is (+), b/c there's now more money in the circular flow