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Consumption & Savings

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.

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Consumption & Savings

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  1. Consumption & Savings MPC, MPS & Multiplier Analysis

  2. 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

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

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

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

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

  7. Savings & Dissavings 45% line Savings Dissavings

  8. DI $100 => C $80 Consumption Function • Autonomous Consumption – there is a minimum amount of consumption per person(people will beg, borrow or steal to consume) • C = 40 + .80 (DI) Autonomous Consumption Marginal Propensity Consume

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

  10. DI $100 => S $20 Savings Function • Autonomous Savings----Savings can be negative since consumption is never zero • S = -40 + .20 (DI) Autonomous Savings Marginal Propensity Save

  11. 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

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

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

  14. Stop Here: Block Period

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

  16. Multiplier • Spending & investment have a “multiple” affect on GDP Government raises spending $100 If MPC = .80 PRODUCT Market Change in GDP: FIRMS HOUSEHOLDS Round 1 $100.0 Round 2 $80.0 Round 3 $64.0 Round 4 $51.2 Etc….. FACTOR Market

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

  18. 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

  19. Multiplier Worksheet

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