Macro Chapter 8

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 and Disposable Income, 1983-2005
45 Reference Line CDI
C
Saving In 1992
Consumption (billions of dollars)
Consumption In 1992
Disposable Income (billions of dollars)
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

8
Average Propensity to Save (APS)

• The fraction or of income that is saved

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

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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

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

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The Multiplier Effect

• Or
• Change in Real GDP multiplier x initial change
  in spending

Multiplier
14
Multiplier Effect and Marginal Propensities

• Multiplier
• -or-
• Multiplier

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

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The Multiplier Effect
(2) Change in Consumption (MPC .75)
(3) Change in Saving (MPS .25)
(1) Change in Income
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
20.00
4.75
15.25
1.58
13.67
2.11
11.56
2.81
8.75
?I 5 billion
3.75
5.00
5.00
1
2
3
4
5
All
Rounds of Spending
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The MPC and the Multiplier
MPC
Multiplier
10
.9
5
.8
4
.75
3
.67
2
.5