Disposable Income (DI)
• Income after taxes on net income
• DI = Gross Income - Taxes
There are 2 choices...
• with disposable income, households can either...
- consume (spend money on goods and services)
- save (not spend money on goods and services)
Consumption
• household spending
• the ability to consume is constrained by...
- the amount of disposable income
- the propensity to save
Do households consume if DI = D?
Yes!
- Autonomous Consumption
- Dissaving
Savings
• households not spending
- the ability to save is constrained by the amount of disposable income
- the propensity to consume
• Do households save if DI = D?
No!
Averse Propensity, Average Propensity to Save
APC & APS
• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1 : Dissaving
• -APS : Dissaving
MPC -Marginal Propensity to Consume
- the fraction of any change in disposable income that is consumed.
MPC = change in consumption divided by change in disposable income
MPS -Marginal Propensity to Save
- the fraction of any change in disposable income that is saved.
MPS = change in savings divided by change in disposable income
Marginal Propensities
• MPC + MPS = 1
• MPC = 1 - MPS
• MPS = 1 - MPC
- people do two things with their disposable income, (CONSUME IT OR SAVE IT)
The spending multiplier effect
- an initial change in spending ( C, Ig, G, Xn) causes a larger change in aggregate spending or aggregate demand (AD)
- multiplier: change in AD divided by change in spending
Calcuating the spending multiplier
- the spending multiplier can be calculated from the MPC or the MPS. Multiplier= 1 divided by 1 - MPC or 1 divided by MPS
- multiplier are (+) when there is an increase in spending and (-) when there is a decrease
Calcuating the tax multiplier
- when the government taxes, the multiplier works in reverse. Why??
• because now more is leaving the circular flow...
- tax multiplier (it's negative)
Formula = MPC divided by 1 - MPC or -MPC divided by MPS
• if there is a tax cut then the multiplier is (+), because there is now more money in the circular flow...
Households are not able to save when they are spending more than their income. There is a term for that and it is called dissaving. Therefore these households are definitely dissaving!
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