mpc mps multipliers

7/30/2019 MPC MPS Multipliers

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AP Macroeconomics

MPC, MPS, and Multipliers


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Disposable Income

Net Income

Paycheck

After-tax income


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Marginal Propensity to Consume(MPC)

The fraction of any change indisposable income that isconsumed.

MPC= Change in Consumption

Change in DisposableIncome

MPC = C/DI


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Marginal Propensity to Save(MPS)

The fraction of any change indisposable income that is saved.

MPS= Change in Savings

Change in Disposable

Income

MPS = S/DI


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Marginal Propensities

MPC + MPS = 1

.: MPC = 1MPS

.: MPS = 1MPC

Remember, people do two

things with their disposableincome, consume it or save it!


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The Spending Multiplier Effect

An initial change in spending (C,IG, G, XN) causes a larger change

in aggregate spending, orAggregate Demand (AD).

Multiplier = Change in ADChange in Spending

Multiplier = AD

/ C, I, G, or X


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Why does this happen?Expenditures and income flow

continuously which sets off aspending increase in the

economy.


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Ex. If the governmentincreases defense spending

by $1 Billion, then defensecontractors will hire and paymore workers, which will

increase aggregatespending by more than theoriginal $1 Billion.


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Calculating the SpendingMultiplier

The Spending Multiplier can becalculated from the MPC or theMPS.

Multiplier = 1/1-MPC or1/MPS

Multipliers are (+) when there is anincrease in spending and () whenthere is a decrease


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Calculating the Tax Multiplier

When the government taxes, themultiplier works in reverse

Why?

Because now money is leaving thecircular flow

Tax Multiplier (note: its negative)

= -MPC/1-MPC or -MPC/MPS If there is a tax-CUT, then the multiplier

is +, because there is now more

money in the circular flow


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MPS, MPC, & Multipliers Ex. Assume U.S. citizens spend 90 for every extra $1 they

earn. Further assume that the real interest rate (r%)decreases, causing a $50 billion increase in gross privateinvestment. Calculate the effect of a $50 billion increasein IG on U.S. Aggregate Demand (AD). Step 1: Calculate the MPC and MPS

MPC = C/DI =.9/1 = .9

MPS = 1MPC = .10

Step 2: Determine which multiplier to use, and whether its + or -

The problem mentions an increase in IG .: use a (+) spendingmultiplier

Step 3: Calculate the Spending and/or Tax Multiplier

1/MPS =

1/.10 = 10

Step 4: Calculate the Change in AD

( C, IG, G, or XN) * Spending Multiplier

($50 billion IG) * (10) =$500 billion AD


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MPS, MPC, & Multipliers

Ex. Assume Germany raises taxes on its citizens by 200billion . Furthermore, assume that Germans save 25% ofthe change in their disposable income. Calculate theeffect the 200 billion change in taxes on the Germaneconomy.

Step 1: Calculate the MPC and MPS MPS = 25%(given in the problem) = .25

MPC = 1MPS = 1 - .25 = .75


The problem mentions an increase in T.: use (-) tax multiplier Step 3: Calculate the Spending and/or Tax Multiplier

-MPC/MPS =

-.75/.25 = -3


( Tax) * Tax Multiplier

(200 billion T) * (-3) = -600 billion in AD


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MPS, MPC, & Multipliers Ex. Assume the Japanese spend 4/5 of their disposable income.

Furthermore, assume that the Japanese government increases itsspending by 50 trillion and in order to maintain a balanced budgetsimultaneously increases taxes by 50 trillion. Calculate the effect the50 trillion change in government spending and 50 trillion change intaxes on Japanese Aggregate Demand. Step 1: Calculate the MPC and MPS

MPC = 4/5 (given in the problem) = .80

MPS = 1MPC = 1 - .80 = .20


The problem mentions an increase in G and an increase in T.:combine a (+) spending with a () tax multiplier

Step 3: Calculate the Spending and Tax Multipliers Spending Multiplier = 1/MPS =

1/.20 = 5

Tax Multiplier = -MPC/MPS =-.80/.20 = -4


[ G * Spending Multiplier] + [ T * Tax Multiplier]

[(50 trillion G) * 5] + [(50 trillion T) * -4]

[ 250 trillion ] + [ - 200 trillion ] = 50 trillion AD


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The Balanced BudgetMultiplier

That last problem was a pain, wasnt it?

Remember when Government Spendingincreases are matched with an equal sizeincrease in taxes, that the change ends upbeing = to the change in Governmentspending

Why? 1/MPS +

-MPC/MPS =1- MPC/MPS =

MPS/MPS = 1

The balanced budget multiplier always = 1

mpc mps multipliers

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