Disposable Income(DI)

DISPOSABLE INCOME

Disposable Income is the income after taxes or net income

DI = Gross Income * Taxes

Two Choices

With Disposable Income, households can…

1.    Consume(Spend money on goods and services)

2.    Save (Not Spend money on goods and services)

Consumption

Household Spending- The ability to consume is constrained by:\

1.    The amount of disposable income

2.    The propensity to save

-Households do consume if DI = 0

*Autonomous Consumption

*Dissaving

Saving

Household not spending – The ability to save is hindered by

1.    The amount of Disposable Income

2.    The propensity to Consume

Do Households save if DI = 0 [NO]

APC [Average Propensity to Save] and APS [Average Propensity to Consume]

·          *APC + APS = 1                    *APC > 1(DISSAVING)           *1 – APC = APS

·         *(-APS) = DISSAVING                          * 1 – APS = APC

MPC [Marginal Propensity to Consume] – The fraction of any change in DI that’s consumed.

·         MPC = Change in Consumption / Change in Disposable Income

MPS[ Marginal Propensity to Save] – The fraction of any change in disposable income that is saved.

·         MPS = Change in Savings / Change in Disposable Income

·         Marginal Propensities

·         MPS + MPS = 1

·         MPC = 1 – MPS

·         MPS = 1 – MPC

·         People do 2 things with their Disposable Income, Consume it or Save it!

The Spending Multiplier Effect

-       An initial change in spending [ C , Ig, G, Xn ] causes a larger change in AS or AD

-       Spending Multiplier can be calculated from the MPC or MPS.

-       Multiplier = AD / Change in (C, Ig, G, or Xn)

-       Multiplier = 1 / (1 – MPC)    or 1/ MPS

-       Multipliers are positive (+) when there is an increase in spending and negative (-) when there is a decrease.

-       Tax Multiplier: When Government taxes, the multiplier works in reverse because money is now leaving the circular flow.

-       Tax Multiplier(Note: is Negative)    - Note: if there is a tax cut, then multiplier is positive, because there is now more money in the circular flow.

-       Tax Multiplier = -MPC / (1 – MPC)  or –MPC / MPS