The Multiplier Effect When firms put more money into investment spending, income levels rise. When income levels rise, consumer spending increases which leads to an increase in output. Marginal Propensity to Consume (MPC): the increase in consumer spending when disposable income rises by $1 Marginal Propensity to Save (MPS): the increase in household savings when disposable income rises by $1.

Equations 1)MPC= Δconsumer spending Δ disposable income Increase in consumer spending when disposable income rises by $1. Δ consumer spending= change in consumer spending Δ disposable income= change in disposable income Ex: If a certain household spends $400 one year and $500 the next year and their disposable income increases from $500 to $800, then the MPC would be 100/300 or 1/3 or ) Total increase in real GDP from $100 billion rise in I= 1/(1-MPC) x 100 billion It is the rise in real GDP (1-MPC)=MPS Ex: The housing market booms one year leading to a construction company building more houses. Because of this, workers are paid more and therefore spend more.

MODULE 16MODULE 16 Group 2 | Mr. GorneyGroup 2 | Mr. Gorney

MULTIPLIER EFFECTMULTIPLIER EFFECT The Multiplier is the ratio of the total change in real GDP by an autonomous change in aggregate spending to the size of that autonomous change. Multiplier Effect= total change in real GDP/Autonomous change in aggregate in spending= 1/(1-Marginal Propensity to consume)

MULTIPLIER EFFECT CONT.MULTIPLIER EFFECT CONT. There can be an endless amount of rounds to the Multiplier Effect because, even though the total rise in GDP is limited to $250 Billion, the MPC continues to happen while shrinking infinitely smaller.

AAS-AUTONOMOUS CHANGE IN AGGREGATE SPENDING AAS-AUTONOMOUS CHANGE IN AGGREGATE SPENDING An initial rise or fall in aggregate spending that is the cause, not the result, of a series of income and spending changes. the total change in real GDP=1/(1-Marginal Propensity to consume) X Autonomous Change in Aggregate Spending

REAL WORLD EXAMPLEREAL WORLD EXAMPLE

Current disposable income is all income after taxes and government transfers that is received by a family, and consumer spending is the money that is spent on final goods and services. Typically, if disposable income is higher, people will spend their money rather than save it.

Consumption Function: An equation showing how individual household’s consumer spending varies with the household’s current disposable income. Autonomous Consumer Spending: The amount of money a household would spend if it had no disposable income Aggregate Consumption Function: The relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending

MPC = Marginal Propensity to consume Consumer spending (C) depends on Disposable income (DI) A is a constant for autonomous consumer spending Yd is disposable income because I is reserved for investment spending c = a + MPCxyd (16-5) Shows how consumer spending varies with disposable income MPC = c/ yd (16-6) The MPC for an individual household MPC x yd = c (16-7) When disposable income goes up by one, the consumer spending goes up by MPC times 1 Slope of Consumption function: (16-8) = Rise over run = c/ yd = MPC Draws a line on a graph. C = A + MPC x Yd (16-9) This is the microeconomic ratio between aggregate current disposable income and aggregate consumer spending The formulas are related because they show how changes in consumer spending and DI affect each other.

Shifts of the Aggregate consumption Function The aggregate consumption function shows the relationship between disposable income and consumer spending for the economy as a whole, all other things being equal. When things other than disposable income change, the aggregate consumption function shifts. There are 2 causes of this shift: Changes in expected future disposable income Changes in aggregate wealth

Changes in expected future disposable income can affect consumer spending. For example suppose you accept a well-paying job immediately after graduating college. But you don’t start receiving paychecks for a few months. You haven’t had a rise in your disposable income yet, but you still start buying more expensive things and spending more money because you know your disposable income will be rising soon and vice versa. Changes in aggregate wealth shows that wealth has an affect on consumer spending. If two people have the same disposable income but one person was already wealthier then the other the wealthier person is more likely to spend more on consumption, despite them having the same disposable income. Causes of Shift

Investment Spending 1.Investment spending is the concept of the production and process of purchasing capital, goods, and services. Investment spending tends to drive the business cycle because declines in consumer spending are usually the result of a process that begins with a slump in investment spending. 2.Planned investment spending is the investment spending that firms intend to undertake during a given period. 3.The interest rate affects investment spending by the interest rate lowering causing firms want to invest more, thus increasing the investment spending. Firms are only willing to contribute to the investment spending if the interest rate is low enough to promise them to have a bigger profit instead of them investing in their product. 4.Future Real GDP and Product Capacity affect the investment spending by a higher expected future growth rate of real GDP results in a higher level of planned investment spending. Product capacity’s current level has a negative effect on investment spending because there is a decline in expected future sales and transactions due to this conundrum.

Inventory and Unplanned Investments Terminology  Inventories: stocks of goods held to satisfy future sales  Inventory Spending: selling the stocks of goods  Unplanned Inventory Spending: unexpected increase in sales depletes inventories and causes the value of unplanned inventory investment to be negative  Actual Investment Spending: sum of planned investment spending and unplanned inventory investment Unplanned Investment Occurrence This occurs when a company determines sales in advance and the sales do not meet the standards expected. Resulting in the company having to adjust for their loss Formula Examination I = I unplanned + I planned I = actual investment spending I unplanned = unplanned investment spending I planned = planned investment spending Real World Example A flower company determines the amount of flowers they will sell for Mother’s Day next month is 7,000. But they only sell 5,000.