Disposable Income Notes

Disposable income (DI)

Income after taxes or net income

DI= Gross Income - taxes

2 choices

With disposable income, households can either 

-Consume (spend money on goods and services)

-Save (not spend money on goods and services)

Consumption 

Household spending

The ability to consume is constrained by

-the amount of disposable income

-the propensity to save

Do households consume if DI=0?

-Autonomous consumption 

-Dissaving

APC=C/DI=% DI that is spent 

SAVING

Household NOT spending

The ability to save is constrained by 

-the amount of disposable income

The propensity to consume

Do households save if DI=0?

-NO

APS= S/ DI= % DI that is not spent 

APC& APS

APC+APS=1

1-APC= APS

1-APS= APC

APC> 1.: Dissaving 

-APS.: Dissaving 

Marginal propensity to Consume

-CHANGE IN C/CHANGE IN DI

-% of every extra dollar earned that is spent 

Marginal propensity to Save 

-CHANGE IN s/CHANGE IN DI

-% of every extra dollar earned that is saved

Mpc+mps=1

1-mpc=mps

The spending multiplier effect 

An initial change in spending causes a larger change in aggregate spending or aggregate demand

Multiplier= Change in AD/ Change in spending

Multiplier = change in AD: change in c,i, g, Xn

Why does this happen?

Expenditures and income flow continuously which sets odds spending increase in the economy. 

The spending multiplier cans be calculated from the mpc of the mps 

Multiplier = 1/1-MPC or 1/MPS

Multipliers are positive when there is an increase in spending and negative when there is a decrease 

Small changes in expenditure are examined by the multiplier effect.

When the government taxes the multiplier works in reverse 

Why?

Because now money is leaving the circular flow

Tax multiplier (it's negative)

•=-MPC/1-MPC or -MPC/ MPS 

If there is a tax cut, then the multiplier is positive because there is now more money in the circular flow