1. Macro Chapter 8 Presentation 1- Marginal Propensities and the Multiplier

2. Income, Consumption, and Savings In general, as income goes up, people spend more---Direct relationship People also tend to save more as income increases Savings = Disposable Income - Consumption

3. 45-Degree Line A reference line used to compare consumption and savings Consumption = DI If you assume that the reference line is DI, then the vertical distance between the 45 degree line and a given consumption line will tell you the amount of savings

4. Income and Consumption Consumption (billions of dollars) Disposable Income (billions of dollars) Consumption and Disposable Income, 1983-2005 45° Reference Line C=DI 83 86 85 84 88 89 91 90 87 92 93 94 95 01 97 96 99 98 00 02 05 03 04 Consumption In 1992 Saving In 1992 45° C

5. Dissaving Spending more on consumption than your after- tax income

6. Break-Even Income The level of disposable income at which households will spend all DI and have zero savings

7. Average Propensity to Consume (APC) the fraction or % of income that is consumed APC = Consumption Income

8. Average Propensity to Save (APS) The fraction or % of income that is saved APS = Saving Income

9. Average Propensities Contd. Since DI is either consumed or saved…. APC + APS = 1 Ex- if APS is.04, APC must be.96

10. Marginal Propensity to Consume (MPC) The fraction that is spent from a change in DI Ex- If income increases from 470B to 490B, and consumption increases from 435B to 450B MPC = (450-435)/490-470= 15/20 =.75 MPC = Change in Consumption Change in Income

11. Marginal Propensity to Save (MPS) Ex. If income increases from 470 B to 490B and Savings increases from 20B to 25B calculate MPS and MPC MPS = (25-20)/(490-470) = 5/20 =.25 *** MPS + MPC = 1 so MPC = 1-.25 =.75 MPS = Change in Saving Change in Income

12. The Multiplier Effect There is a direct relationship between changes in spending and real GDP ***A change in total spending leads to a larger change in GDP (multiplies) The money initially spent goes to profits, wages, rents etc. which are then spent in a chain reaction down the line

13. The Multiplier Effect Or Change in Real GDP = multiplier x initial change in spending Multiplier = Change in Real GDP Initial Change in Spending

14. Multiplier Effect and Marginal Propensities Multiplier = -or- Multiplier = 1 1 - MPC 1 MPS

15. Sample Problem The MPC is.8 and a business increases investment by $5 Billion. What is the multiplier? How much increase in GDP? Multiplier = 1/MPS or 1/1-MPC = 1/(1-.8) = 5 GDP = 5 x 5 = 25 Billion increase

16. The Multiplier Effect (1) Change in Income (2) Change in Consumption (MPC =.75) (3) Change in Saving (MPS =.25) Increase in investment of $5 Second Round Third Round Fourth Round Fifth Round All other rounds Total $ 5.00 3.75 2.81 2.11 1.58 4.75 $ 20.00 $ 3.75 2.81 2.11 1.58 1.19 3.56 $ 15.00 $ 1.25.94.70.53.39 1.19 $ 5.00 Rounds of Spending 12345All $20.00 15.25 13.67 11.56 8.75 5.00 $5.00 $3.75 $2.81 $2.11 $1.58 $4.75 ΔI= $5 billion

17. The MPC and the Multiplier 10 5 4 3 2.5.67.75.8.9 MPCMultiplier