1. Fun!!! With the MPC, MPS, and Multipliers Special thanks to Mr. David Mayer & Mr. Ken Norman from whom I adapted this power point

2. Marginal Propensity to Consume (MPC) The fraction of any change in disposable income that is consumed. MPC= Change in Consumption Change in Disposable Income MPC = ΔC / ΔDI

3. Marginal Propensity to Save (MPS) The fraction of any change in disposable income that is saved. MPS= Change in Savings Change in Disposable Income MPS = ΔS / ΔDI

4. Marginal Propensities MPC + MPS = 1 –.: MPC = 1 – MPS –.: MPS = 1 – MPC Remember, people do two things with their disposable income, consume it or save it!

5. The Spending Multiplier Effect An initial change in spending (C, I, G, NX) causes a larger change in aggregate spending, or Aggregate Demand (AD).

6. The Spending Multiplier Effect Why does this happen? –Expenditures and income flow continuously which sets off a spending increase in the economy.

7. The Spending Multiplier Effect –Ex. If the government increases highway spending by $200 billion, then highway contractors will hire and pay more workers, which will increase aggregate spending by more than the original $200 billion.

8. The First Round of Government Spending Causes The Biggest Splash MPC of 75% G spends $ 200 billion on the highways. The First Round of Government Spending Causes The Biggest Splash MPC of 75% G spends $ 200 billion on the highways. Highway workers save 25% of $200 billion [$50 billion] & spend 75% or $150 billion on boats. Boat makers save 25% of $150 bil. [$37.50 bil.] & spend 75% or $112.50 bil. on iPod Minis, etc.

9. Calculating the Spending Multiplier The Spending Multiplier can be calculated from the MPC or the MPS. Multiplier = 1 / 1-MPC or 1 / MPS Multipliers are (+) when there is an increase in spending and (–) when there is a decrease

10. MPC 1/MPS = M.901/.10= 10.801/.20= 5.751/.25= 4.601/.40= 2.5.501/.50= 2 Expenditure Multiplier M E [Change in G, I, or NX] = 1/MPS

11. Calculating the Tax Multiplier When the government taxes, the multiplier works in reverse Why? –Disposable income is decreased, meaning we spend less Tax Multiplier = MPC / 1-MPC or MPC / MPS –Its negative if taxes are increasing –Its positive if taxes are decreasing

12. MPC MPC/MPS = M.90-MPC/.10= -9.80-MPC/.20= -4.75-MPC/.25= -3.60-MPC/.40= -1.5.50-MPC/.50= -1 Tax Multiplier M T [Change in Taxes] = - MPC/MPS

13. MTMTMTMT -4 -3 -1.5 -9 M T = MPC/MPS M E = 1/MPS MPC MEMEMEME.9 10.85.75 4.60 2.5.5 2 larger the MPCsmaller the MPS The larger the MPC, the smaller the MPS, and the greater the multiplier greater the multiplier. tax multiplier The tax multiplier is always one less than the spending multiplier.

14. The Balanced Budget Multiplier in G = in T When Government Spending increases are matched with an equal size increase in taxes, that change ends up being = to the change in Government spending Why? Mathematically - 1 / MPS + -MPC / MPS = 1- MPC / MPS = MPS / MPS = 1 Economically - Part of any tax change effects savings, meaning the change in spending due to the tax change is always less The balanced budget multiplier always = 1

15. Multiplier Practice Assume US citizens spend $.90 for every extra $1 they earn. Further assume that the real interest rate (i) decreases, causing a $50 billion increase in Investment (I). Calculate the effect of this increase in spending on AD.

16.  Step 1: Calculate the MPC and MPS  MPC = C / DI  MPS = 1- MPC =  Step 2: Determine which multiplier to use, and whether its + or –  The problem mentions an increase in I, use a (+) spending multiplier  Step 3: Calculate the Spending and/or Tax Multiplier  Step 4: Calculate the Change in AD  ( C, I, G or NX) * Spending or Tax Multiplier

17. More Practice Assume Germany raises taxes on its citizens by 200b. Assume that Germans save 25% of the change in their disposable income. Calculate the effect of these taxes on the German economy.

18. More Practice Assume the Japanese spend 4/5 of their disposable income. Assume that the Japanese government increases its spending by 50 trillion and in order to maintain a balanced budget simultaneously increase taxes by 50t. Calculate the effect of these changes on the Japanese Aggregate Demand.