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. Total Spending has already reached $462.50b
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 $ bil. on iPod Minis, etc.
Total Spending has already reached $462.50b

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. Expenditure Multiplier ME [Change in G, I, or NX] = 1/MPS
MPC 1/MPS = M
.90 1/.10 = 10
.80 1/.20 = 5
.75 1/.25 = 4
.60 1/.40 = 2.5
.50 1/.50 = 2
Expenditure Multiplier
ME [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. MT [Change in Taxes] = -MPC/MPS
Tax Multiplier
MT [Change in Taxes] = -MPC/MPS
MPC MPC/MPS = M
.90 -MPC/.10 = -9
.80 -MPC/.20 = -4
.75 -MPC/.25 = -3
.60 -MPC/.40 =
.50 -MPC/.50 = -1

13. ME = 1/MPS MT = MPC/MPS ME MT .9 10 -9 .8 5 -4 .75 4 -3 .60 2.5 .5 2 -9
.8 5 -4 -3
-1.5
The larger the MPC, the smaller the MPS, and the
greater the multiplier. -1
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 = 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.