With disposable income, households can either

o   Consume (spend money on goods and services )

o   Save ( not spending money on goods and services )

·         Disposable Income ( DI )

o   Income after taxes or net income

o   DI = Gross Income – Taxes

·         Consumption

o   Household spending

o   Ability to consume constrained by

o   The propensity to save

§  Do households consume if DI = 0?

·         Autonomous

·         Saving

o   Household not spending

o   Amount of disposable income

o   Propensity to consume

§  So households save if DI = 0?

·         No

Ø  APS= S / DI = % DI that is not spent

Ø  APC and APS

o   APC + APS = 1

o   1 – APC = APS

o   1 – APS = APC

o   APC > 1 : Dissaving

o   –APS: Dissaving

Ø  MPC and MPS

o   Marginal Propensity to consume

§  changeC / changeDI

§  Percent of every extra money earned that is spent

o   Marginal Propensity to save

§   change S / changeDI

§  Percent every extra money earned is saved

o   1 – MPC = MPS  

o   1 – MPS = MPC

Spending Multiplier Effect

·         Initial change spending ( C, Ig, G, Xn)  causes a larger change in aggregate spending, or aggregate demand ( AD )

·         Multiplier =           Change in AD___

Change in spending

·         Multiplier = changeAD / change C, I , G, or Xn

·         Expenditures and income flow continuously sets off a spending increase in economy.

·         Spending Multiplier can be calculated from the MPC or MPS

·         Multiplier = 1/1-MPC or 1/MPS

·         Multiplier are positive when there is an increase in spending and negative when there is a decrease.

·         The government taxes the multiplier works in reverse.

o    Because money is leaving the circular flow

o   Tax Multiplier (negative)

§  -MPC/ 1-MPC or –MPC/MPS

If tax – cut, multiplier is positive because now money is in the circular flow