Alphabet Soup and Economics

1. Alphabet Soup and Economics J.A.SACCO

2. Real Consumption and Saving Schedules: A Hypothetical Case (1) (2) (3) (4) (5) (6) (7) Planned Average Average Real Planned Real Saving Propensity Propensity Marginal Marginal Disposal Real Con- Per Year to Consume to Save Propensity Propensity Income per sumption (S=Yd-C) (APC=C/Yd) (APS=S/Yd) to Consume to Save Combination Year (Yd) per year (C) (1) - (2) (2)/(1) (3)/(1) ---- .8 .8 .8 .8 .8 .8 .8 .8 .8 .8 A$0 B 2,000 C 4,000 D 6,000 E 8,000 F 10,000 G 12,000 H 14,000 I 16,000 J 18,000 K 20,000 ---- 1.8 1.3 1.133 1.05 1.0 .967 .943 .925 .911 .9 ---- -.8 -.3 0.133 -.05 .0 .033 .057 .075 .089 .1 ---- .2 .2 .2 .2 .2 .2 .2 .2 .2 .2 $2,000 3,600 5,200 6,800 8,400 10,000 11,600 13,200 14,800 16,400 18,000 $-2,000 -1,600 -1,200 -800 -400 0 400 800 1,200 1,600 2,000 Looked at the basics of the Consumption function, now lets look at how a change in disposable income affects consumption and saving habits.

3. Determinants of Planned Consumption and Planned Saving • Average Propensity to Consume (APC) • Consumption divided by disposable income • The proportion of total disposable income that is consumed Or C/Yd

4. Determinants of Planned Consumption and Planned Saving • Average Propensity to Save (APS) • Saving divided by disposable income • The proportion of total disposable income that is saved Or S/Yd

5. Determinants of Planned Consumption and Planned Saving Since the proportion of income spent and saved must equal 100% of disposable income, then the

6. Determinants of Planned Consumption and Planned Saving • For Example: Real Disposable Income (RDI)=$6000 Consumption (C)=$5800, Saving(S)=$200 APC=C/RDI=$5800/$6000=0.967 APS=S/RDI=$200/$6000=0.033 APC+APS=0.967(APC)+0.033(APS)=1.00ALWAYS Equals 1.00!

7. Determinants of Planned Consumption and Planned Saving • Example • Income = $18,000 • C= $16,400 • S = $1,600

8. Determinants of Planned Consumption and Planned Saving • Example • Income increases $2,000 to $20,000 • C = $18,000 • S = $2,000

9. Determinants of Planned Consumption and Planned Saving • Question • What is your APC and APS?

10. Determinants of Planned Consumption and Planned Saving • Marginal Propensity to Consume (MPC). • The ratio of the change in consumption to the change in disposable income. • Percentage of any additionaldisposable income that is consumed. Or ΔC/ΔRDI

11. Determinants of Planned Consumption and Planned Saving • Marginal Propensity to Save (MPS). • The ratio of the change in saving to the change in disposable income. • The percentage of any additional income that is saved. Or ΔS/ΔRDI

12. Determinants of Planned Consumption and Planned Saving • Since 100% of any change in disposable income must be consumed or saved, then the MPC +MPS=1. • For Example- RDI increases by $1000, consumption increases by $800, and saving increases by $200. MPC= Change in C/Change in Income=$800/$1000=0.8 or 80% of NEW income consumed. MPS= Change in S/Change in Income=$200/$1000=0.2 or 20% of NEW income saved. Therefore-MPC+MPS=0.8+ 0.2= 1.00. ALWAYS EQUALS 1. Note- MPC is constant slope of consumption function. MPS is constant slope of saving function.

13. Determinants of Planned Consumption and Planned Saving • Example Income1 = $18,000 Income1 = $20,000 C1 = 16,400 C2 = 18,000 S1 = 1,600 S2 = 2,000 3) APC? 4) APS? 5) MPC? 6) MPS? 1) APC? 2) APS?

14. Determinants of Planned Consumption and Planned Saving • Then if:

15. Quick Quiz • The proportion of any additional income that is consumed is the _______ propensity to ________. • The proportion of total disposable income that is saved is the _______ propensity to _____. marginal consume average save Khan Academy- MPC and the Multiplier