Macro Chapter 8
Presentation 1- Marginal Propensities
and the Multiplier
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
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
Income and Consumption
Consumption
and Disposable Income, 1983-2005
10000
Consumption (billions of dollars)
9000
05
45° Reference Line
C=DI
8000
04
03
01
7000
02
00
C
99
6000
Saving
In 1992
5000
98
97
96
95
94
93
92
4000
3000
83
2000
84
88
87
86
85
91
90
89
Consumption
In 1992
1000
45°
0
0
2000
4000
6000
8000
Disposable Income (billions of dollars)
10000
Dissaving
• Spending more on
consumption than your aftertax income
Break-Even Income
• The level of disposable income
at which households will
spend all DI and have zero
savings
Average Propensity to Consume (APC)
• the fraction or % of income that
is consumed
Consumption
APC =
Income
Average Propensity to Save (APS)
• The fraction or % of income
that is saved
Saving
APS =
Income
Average Propensities Contd.
• Since DI is either consumed or
saved….
• APC + APS = 1
• Ex- if APS is .04, APC must be .96
Marginal Propensity to Consume
(MPC)
MPC =
Change in Consumption
Change in Income
• 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
Marginal Propensity to Save (MPS)
MPS =
Change in Saving
Change in Income
• 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
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
The Multiplier Effect
Change in Real GDP
Multiplier =
Initial Change in Spending
• Or
• Change in Real GDP = multiplier x initial
change in spending
Multiplier Effect and Marginal
Propensities
Multiplier =
1
1 - MPC
-orMultiplier =
1
MPS
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
The Multiplier Effect
Increase in investment of $5
Second Round
Third Round
Fourth Round
Fifth Round
All other rounds
Total
$20.00
(1)
Change in
Income
$ 5.00
3.75
2.81
2.11
1.58
4.75
$ 20.00
$4.75
15.25
13.67
11.56
8.75
5.00
(2)
(3)
Change in
Change in
Consumption
Saving
(MPC = .75) (MPS = .25)
$ 3.75
$ 1.25
2.81
.94
2.11
.70
1.58
.53
1.19
.39
3.56
1.19
$ 15.00
$ 5.00
$1.58
$2.11
$2.81
ΔI=
$5 billion
$3.75
$5.00
1
2
3
4
Rounds of Spending
5
All
The MPC and the Multiplier
MPC
Multiplier
.9
10
.8
5
.75
4
.67
.5
3
2