disposable (after-tax) income and whether people choose to save or to spend.

Define the average propensity to consume (APC)

The proportion of disposable income that a person spends.

what is the equation for APC

APC= Consumption/Disposable Income

Define Average Propensity to save (APS)

the proportion of disposable income that a person saves.

Equation for APS

APS= Saving/Disposable Income

Because people have only two choices – to spend or to save- what is reasonable regarding what makes up Disposable income (DI) and the sum of APC and APS ?

Consumption + Savings = DI

Consequently, APC + APS = 1

Remember–what does “marginal “mean?

adding or subtracting from the current situation.

Define the marginal propensity to consume (MPC)

the additional spending that results when a consumer receives additional disposable income.

Equation for MPC

MPC= Change in Consumption/Change in Disposable Income

Define marginal propensity to save (MPS)

the additional saving that results when a consumer receives additional disposable income.

What does MPC + MPS equal?

1

Why does every dollar spent in the economy have a greater than one dollar effect on GDP?

It matters because every dollar that is spent in the economy has a greater than one dollar effect on GDP.

What does the MPC determine in regards to a change in spending?
The higher the MPC….
The lower the MPC…

The MPC determines how big the ripple effect will be. The higher the MPC, the bigger the ripple effect; the lower the MPC, the smaller the ripple effect.

We can determine the size of a spending change by using what?

spending multiplier equation

Spending Multiplier equation

(1)/(1-MPC)=(1)/(MPS)

When should you use the spending multiplier?

When there is a change in a component of AD.

How do you use the spending multiplier?

By multiplying the change in the AD component times the spending multiplier.

Equation: Change in real GDP=

change in the AD component x the spending multiplier

How is the tax multiplier different?

First, it is negative because an increase in taxes decreases disposable income. Because of the inverse affect of taxes, the multiplier has a negative sign.

Second, changes in C, I, G, and NX immediately affect spending but a change in taxes must change disposable income before it changes spending. In other words, spending will not change by the amount of the tax change because the tax change is subject to the MPC first. Instead, a $1 change in taxes will only change spending by $1 x MPC.

What is the Tax Multiplier?

(-MPC)/(1-MPC)=(-MPC)/(MPS)

When are you supposed to use the tax multiplier?

When there is a change in lump-sum taxes that affects AD

How are you supposed to use the tax multiplier?

By multiplying the change in taxes by the taxes multiplier.

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