Consumption Savings MPC MPS Multiplier Analysis 2 Methods

Consumption & Savings MPC, MPS & Multiplier Analysis

2 Methods to Calculate GDP • Expenditure Method: GDP = AD = C + I + G + NX • Income Method GDP = Y = wages + interest + rents + profits • Both methods yield same result: EXPENDITURE = INCOME

SPENDING = INCOME Y = AD = Real GDP Income or Aggregate Output Y = INCOME S = SAVINGS Spending or Aggregate Expenditure C = CONSUMPTION

Disposable Income (DI) • What consumers have left over after taxes – DI = Gross Income – Net Taxes • With no Government taxes or transfers: – DI = Consumption + Savings [S] FIRMS Consumption [C] HOUSEHOLDS Aggregate Income [Y]

Consumption • Consumption is a function of disposable income (DI) DI C

Marginal Propensity to Consume • Slope of the consumption function is the marginal propensity to consume (MPC) MPC = ∆C / ∆ DI

Savings & Dissavings 45% line Savings Dissavings

Consumption Function • Autonomous Consumption – there is a minimum amount of consumption person (people will beg, borrow or steal to consume) Disposable Income • C = 40 +. 80 (DI) Consumption [C] Savings [S] 0 40 -40 100 120 -20 200 0 300 280 20 400 360 40 Autonomous Consumption Marginal Propensity Consume DI => C $100 $80

Savings • Savings = DI – Consumption ( S = DI – C ) • MPS = ∆S / ∆ DI • MPC + MPS = 1 fraction of income consumed fraction of income saved Must be true because everything not saved is consumed: DI = C + S

Savings Function • Autonomous Savings----Savings can be negative since consumption is never zero • S = -40 +. 20 (DI) Disposable Income Consumption [C] Savings [S] 0 40 -40 100 120 -20 200 0 300 280 20 400 360 40 Autonomous Savings Marginal Propensity Save DI => S $100 $20

Changes in Consumption & Savings • Changes in disposable income cause movements along the consumption & savings function • Changes in these 4 -factors cause shift in each function – Wealth – Expectations – Household Debt – Taxes & Transfers

Taxes & Transfers: Only item to shifts savings & consumption function in same direction Taxes C Taxes S

Worksheet: Part 1 MPC & MPS 45% line Savings Have students complete #1 -#8 on handout Dissavings

Stop Here: Block Period

Investment & Gov’t Spending Multiplier • Multiplier = ∆GDP / ∆ Gov’t Spending • MPC & MPS determine investment or spending multiplier • 2 -ways to calculate multiplier: • Multiplier = 1/(1 -MPC) Example: MPC =. 80 or (if you know MPC & MPS) 1/MPS 1/(1 -. 80) = 5

Multiplier • Spending & investment have a “multiple” affect on GDP Government raises spending $100 If MPC =. 80 PRODUCT Market Change in GDP: FIRMS HOUSEHOLDS FACTOR Market Round 1 $100. 0 Round 2 $80. 0 Round 3 $64. 0 Round 4 $51. 2 Etc…. .

The Tax Multiplier • Multiplier = ∆GDP / ∆ Taxes • Is always smaller than spending/investment multiplier • TM = -MPC * (spending multiplier) • Example: $200 tax cut Example: or -MPC/MPS MPC =. 80 TM = -. 80 * 5 = -4 1/(1 -. 80) = 5

Balanced Budget Multiplier • Always equal to 1 (regardless of MPC) • Assume Government ↑ Taxes & ↑ Spending – By same $ amount – MPC =. 90 Example: Spending Multiplier = 10 Tax Multiplier = 9 Always a difference of 1

Multiplier Worksheet