CONSUMPTION AND SAVING

CONSUMPTION AND SAVING





Disposable income (DI) is income after taxes or net income. With disposable income, households have two choices, they can...:

  • consume 
  • save 
Consumption (C) is household spending. Households consume if DI = 0 through autonomous consumption and dissaving. The ability to consume is forced by:
  • the amount of DI
  • the propensity to save
Saving (S) is when the household is NOT spending. Households do NOT save if DI = 0. The ability to save is constrained by:
  • The amount of DI
  • The propensity to consume
Here are some formulas and information about average propensity to consume (APC) and average propensity to save (APS):
  • APC + APS = 1
  • 1 - APC = APS
  • 1 - APS = APC
  • APC > 1 (dissaving)
  • -APS (dissaving)


Marginal propensity to consume (MPC) is the percentage of every extra dollar earned that is spent. It is also the fraction of any change in DI that is consumed. Its equations are...:
  • MPC = (change in consumption)/(change in DI) = ΔC/ΔDI
  • MPC = 1 - MPS


Marginal propensity to save (MPC) is the percentage of every extra dollar earned that is saved. It is also the fraction of any change in DI that is saved. Its equations are as follows:
  • MPS = (change in savings)/(change in DI) = ΔS/ΔDI
  • MPS = 1 - MPC


The spending multiplier effect is when an initial change in spending (C, I, G, and/or X) causes a larger change in aggregate spending, or aggregate demand (AD). This happens because expenditures and income flow continuously which sets off a spending increase in the economy. The equation is...:
Multiplier = (change in AD)/(change in spending) = ΔAD/ΔC, ΔI, ΔG, or ΔX

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

When the government taxes, the multiplier works in reverse because now money is leaving the circular flow. If there is a tax cut, then the multiplier is positive, because there is now more money in the circular flow. The equation is as... (it's always negative):
Tax Multiplier = (-MPC)/(1 - MPC) = (-MPC)/(MPS)

If you're still confused, here are some vids 2 help :) :

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