Consumption and Savings

Consumption

Disposable Income (DI)

• the net income or the income after taxes
• DI= Gross Income - taxes
• Households can either consume or save disposable income

Consumption

Household spending

The ability to consume is constrained by - the amount of disposable income and the propensity to save   

Savings

• Household are not spending
• The ability to save is constrained by the amount of disposable income and the propensity to consume

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) and Marginal Propensity to Save (MPS)

• Marginal propensity to consume - ΔC/ CD 
• % of every extra dollar earned that is spent

• Marginal Propensity to save - ΔS/ ΔDI
• % of every extra dollar earned that is saved

• MPC + MPS = 1
• 1 - MPC = MPS
• 1 - MPS = MPC

Spending Multiplier

• An initial change in spending (C, IG, G, XN) causes a larger change in Aggregate Spending, or Aggregate Demand
• Multiplier = Δ AD / Δ C,I,G,or X
• Multiplier = 1 / (1-MPC) or 1/MPS
• Multipliers are positive when there is an increase in spending and negative when there is a decrease

Tax Multiplier

• When the government taxes, the multiplier works inverse
• Tax Multiplier = -MPC / (1-MPC) or -MPC / MPS
• If there is a tax-cut, then the multiplier is positive