Disposable
Income: Key
Average
Propensity to Consume (% or Fraction):
The average of what people will consume.
Average
Propensity to Save (% or Fraction): The average of what people will save.
APC
+ APS will always = one.
Marginal
Analysis: What happens when a new unit
is added?
MPC
= What % of new Disposable Income will people consume.
MPS
= What % of new Disposable Income will people save.
MPC
+ MPS will always = one.
The Spending
Multiplier Effect
Assume
new marginal income is created.
Example: tax cut.
Assume
that the tax cut averages a new $1000 of disposable income.
Assume
that the current MPC will be 90% and the MPS will be 10%.
Person
|
MPC
|
MPS
|
First to get the new $
|
$ 900.00
|
$100.00
|
Second to use that $
|
$ 810.00
|
$ 90.00
|
Third to use that $
|
$ 729.00
|
$ 81.00
|
Fourth to use that $
|
$ 656.10
|
$ 72.90
|
Fifth to use that $
|
$ 590.49
|
$ 65.61
|
Total So Far of the Original $1000
|
$3685.59
|
$409.51
|
Notice: For each person getting a new $1000, several
consumption events
can
occur from that single amount of money.
How long will the pattern continue?
Economists use the Spending Multiplier Formula to estimate the number of
times the pattern will repeat before the amount shrinks to a point where new
spending stops. The formula is: 1/1-MPC, or 1/MPS.
Therefore,
if the MPC is .9, how many new dollars of consumption will be created if
society receives $1 million dollars? $10
million.
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