Consumption and savings

Disposable Income (DI)

• Income after taxes or net income
• DI = Gross Income - Taxes

2 Choices

• With disposable income, households can either
• Consume (spend money on goods and dervices)
• 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 housholds consume if DI = 0?
• Autonomous consumption
• Dissaving

Saving

• Household NOT spending
• The ability to save is constrained by 
• The amount of disposable income
• The propensity to consume
• Do households save if DI = 0? NO

APC & APS

• Average propensity to consume/save
• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC >1 .: Dissaving
• -APS .: Dissaving

MPC & MPS

• Marginal propensity to consume
• 𝚫C/𝚫DI
• % of every extra follar earned that is spent
• Marginal propensity to save
• 𝚫S/𝚫DI
• % of every extra dollar earned that is saved
• MPC + MPS = 1
• 1 - MPC = MPS
• 1 - MPS = MPC

The Spending Multiplier Effect

• An initial change in spending (C, Ig, G, Xn) causes a larger change in AS or AD
• Multiplier = 𝚫AD/𝚫Spending (C, Ig, G, Xn)
• Why? Expenditures and income flow continuously which sets off a spending increase in the economy.

Calculating the Spending Multiplier

• The Spending Multiplier can be calculated from the MPC or the MPS.
• Multiplier = 1/(1 - MPC) or 1/MPS
• Multipliers are (+) when there is an increase in spending and (-) when there is a decrease.

Calculating the Tax Multiplier

• When the government taxes, the multiplier works in reverse.
• Why? Because now money is leaving the circular flow.
• Tax Multiplier (note: it's negative)
• = -MPC/(1 - MPC) or -MPC/MPS
• If there is a tax CUT, then the multiplier is (+), because there is now more money in the circular flow.