Spending Multiplier

Spending Multiplier

 Terms and Concepts to Cover:

  Disposable Income = Consumption + Savings

  Average Propensity

  Marginal Propensity

  APC, APS (APC + APS = 1)

  MPC, MPS (MPC + MPS =1)

  Spending Multiplier Formulas:   __1___    or     __1___

                                                        1-MPC             MPS

  Links between changes in Consumption and Savings = Policy Goals

Disposable Income

APC (as a % or Fraction):  The average of what people will __________.

APS (as a % or Fraction):  The average of what people will __________.

APC + APS will always = ______.

Marginal Analysis:  What happens when a new unit is added?

MPC = What % of new DI will people ___________.

MPS = What % of new DI will people ___________.

MPC + MPS will always = ______.

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 $
Second to use that $
Third to use that $
Fourth to use that $
Fifth to use that $
Total So Far of the Original $1000

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?  ________.

How many new dollars of consumption will be created if the MPC is only .5? ___________.