Marginal Propensity to Consume

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Presentation transcript:

Marginal Propensity to Consume The increase in consumer spending when disposable income rises by $1. Disposable income is the money one has after paying taxes (the money one has to live on).

Marginal Propensity to Save The increase in household savings when disposable income rises by $1

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. (autonomous means “self-governing”)

The Multiplier The multiplier shows how initial changes in spending lead to further changes. The ratio of the total change in real GDP caused by an autonomous change in Aggregate Spending to the size of that autonomous change

The Multiplier The federal government recently enacted the American Recovery and Reinvestment Act of 2009. This “stimulus package” of $787 billion was intended to spark job growth to reverse the worst recession since the Great Depression. How was this supposed to work?

The Multiplier The short answer is that $1 of spending in one area of the economy multiplies into more than $1 of spending throughout the economy.

The Marginal Propensity to Consume Consumption is a huge fraction (more than 2/3) of total spending in the economy. After a person pays his taxes, he is left with disposable income (Yd) that can either be consumed or saved. Yd = C + S

The Marginal Propensity to Consume When a person gets more disposable income, Yd, he will increase both C and S. The marginal propensity to consume (MPC) = change in consumption/change in disposable income. The marginal propensity to save MPS = Change in Saving/Change in Disposable Income MPC + MPS = 1

The Consumption Function The Consumption Function is an equation showing how an individual household’s consumer spending varies with the household’s current disposable income.