Disposable income and Multiplier's

Disposable Income (DI)

1. Income after taxes or net income
2. DI = Gross Income - Taxes

2 Choices

1. With disposable income, households can either
1. Consume (spend money on goods and services)
2. Save (not spend money on goods and services)

Consumption

• Household spending
• The ability to consume is constrained by:
• The amount of disposable income
• The propensity to save
• Do households consume if DI = 0?
• Autonomous consumption
• Dissaving
• APC = C/DI = % DI that is spent

Saving

• Household NOT spending
• The ability to save is constrained by:
• The amount of DI
• The propensity to consume
• Do households save if DI = 0? No.
• APS = S/DI = % DI that is not spent

APC & APS

• APC + APS = 1
• 1 - APC = APS
• 1 - APS = APC
• APC > 1 : Dissaving
• - APS . Dissaving

MPC and MPS

• Marginal Propensity to Consume
• △C/△DI
• % of every extra dollar earned that is spent
• Marginal Propensity to Save
• △S/△DI
• % of every extra dollar earned that is saved
• MPC + MPS = 1
• 1 - MPC = MPS
• 1 - MPS = MPC

The Spending Multiplier Effect

• An initial change in spending (C, G, Ig, Xn) causes larger change in aggregate spending (or AD)
• Multiplier = △in AD/△in spending
• Multiplier = △in AD/△C, G, Ig, Xn

• Why does this happen?
• Expenditures and income flow continuously which then sets off a spending increase in the economy

• Can be calculated from MPC or MPS
• Multiplier = 1/1-MPC or 1/MPS
• Multipliers are + when there is an increase in spending and - when there is a decrease

Tax Multiplier

• When government taxes, multiplier works in reverse b/c money is leaving circular flow
• Tax Multiplier Formula (it's negative) = -MPC/1-MPC or -MPC/MPS
• If there is a tax CUT, multiplier is + because there is now more money in the circular flow