Fun!!! With the
MPC, MPS, and
Multipliers
Special thanks to Mr. David Mayer
& Mr. Ken Norman from whom I
adapted this power point
Marginal Propensity to Consume
(MPC)
• The fraction of any change in
disposable income that is consumed.
• MPC= Change in Consumption
Change in Disposable Income
• MPC = ΔC/ΔDI
Marginal Propensity to Save (MPS)
• The fraction of any change in
disposable income that is saved.
• MPS= Change in Savings
Change in Disposable Income
• MPS = ΔS/ΔDI
Marginal Propensities
• MPC + MPS = 1
–.: MPC = 1 – MPS
–.: MPS = 1 – MPC
• Remember, people do two things
with their disposable income,
consume it or save it!
The Spending Multiplier Effect
• An initial change in spending (C,
I, G, NX) causes a larger change
in aggregate spending, or
Aggregate Demand (AD).
The Spending Multiplier Effect
• Why does this happen?
–Expenditures and income flow
continuously which sets off a
spending increase in the
economy.
The Spending Multiplier Effect
–Ex. If the government increases
highway spending by $200
billion, then highway contractors
will hire and pay more workers,
which will increase aggregate
spending by more than the
original $200 billion.
The First Round of Government
Spending Causes The Biggest Splash
MPC of 75%
G spends $200 billion on the highways.
Highway workers save 25% of $200 billion [$50
billion] & spend 75% or $150 billion on boats.
Boat makers save 25% of $150 bil. [$37.50 bil.]
& spend 75% or $112.50 bil. on iPod Minis, etc.
Calculating the Spending Multiplier
• The Spending Multiplier can be
calculated from the MPC or the MPS.
• Multiplier = 1/1-MPC
or 1/MPS
• Multipliers are (+) when there is an
increase in spending and (–) when
there is a decrease
Expenditure Multiplier
ME [Change in G, I, or NX] = 1/MPS
MPC
.90
.80
.75
.60
.50
1/MPS
1/.10
1/.20
1/.25
1/.40
1/.50
= M
= 10
=
5
=
4
= 2.5
=
2
Calculating the Tax Multiplier
• When the government taxes, the multiplier
works in reverse
• Why?
– Disposable income is decreased, meaning we
spend less
• Tax Multiplier
=
MPC/
1-MPC
or
MPC/
MPS
– Its negative if taxes are increasing
– Its positive if taxes are decreasing
Tax Multiplier
MT [Change in Taxes] = -MPC/MPS
MPC
.90
.80
.75
.60
.50
= M
-MPC/.10=
-9
-MPC/.20=
-4
-MPC/.25=
-3
-MPC/.40= -1.5
-MPC/.50=
-1
MPC/MPS
MT = MPC/MPS
MT
-9
ME = 1/MPS
ME
MPC
.9
10
.8
5
.75
4 -3
-4
.60 2.5 -1.5
.5
2 -1
The larger the MPC, the smaller the MPS, and the
greater the multiplier.
The tax multiplier is always one less than the
spending multiplier.
The Balanced Budget Multiplier
in G =
in T
• When Government Spending increases are matched
with an equal size increase in taxes, that change ends
up being = to the change in Government spending
• Why?
Mathematically - 1/MPS + -MPC/MPS = 1- MPC/MPS = MPS/MPS = 1
Economically - Part of any tax change effects savings, meaning
the change in spending due to the tax change is always less
• The balanced budget multiplier always = 1
Multiplier Practice
• Assume US citizens spend $.90 for every
extra $1 they earn.
• Further assume that the real interest rate
(i) decreases, causing a $50 billion
increase in Investment (I).
• Calculate the effect of this increase in
spending on AD.
Step 1: Calculate the MPC and MPS
MPC = C / DI
MPS = 1- MPC =
Step 2: Determine which multiplier to use, and
whether its + or –
The problem mentions an increase in I, use a (+)
spending multiplier
Step 3: Calculate the Spending and/or Tax
Multiplier
Step 4: Calculate the Change in AD
(
C, I, G or NX) * Spending or Tax Multiplier
More Practice
• Assume Germany raises taxes on its
citizens by 200b.
• Assume that Germans save 25% of the
change in their disposable income.
• Calculate the effect of these taxes on the
German economy.
More Practice
• Assume the Japanese spend 4/5 of their
disposable income.
• Assume that the Japanese government
increases its spending by 50 trillion and
in order to maintain a balanced budget
simultaneously increase taxes by 50t.
• Calculate the effect of these changes on
the Japanese Aggregate Demand.