Consumption Function, MPS, MPC, Multipliers

1. How does Money affect Aggregate Demand? The Consumption Function, Investment Demand, and The Multiplier

2. What would each of the following to do with an extra $1000? 1. A single female working for a high-paying IT company in India. 2. A middle-class couple whose computer is broken, but who has hopes of sending their children to college. 3. A male from a lower-class family who wants to pursue an advanced degree in engineering.

3. How Can you Spend Your Money? Disposable Income (DI)= Salary – taxes  Can be spent on Consumption or Savings

4. The Consumption Function

5. CONSUMPTION FUNCTION, WHAT’S YOUR FUNCTION? CONSUMPTION and DISPOSABLE INCOME! JINGLE

6. If at 45°, C = DI … Dissavings: C> DI A, B, C Savings: C < DI E, F

7. MPC and MPS MARGINAL PROPENSITY TO CONSUME MARGINAL PROPENSITY TO SAVE If you receive extra income MPC is the % of the money you use on consumption MPC= ΔC / ΔDI MPS is the % of the money you put in savings MPS = ΔS / ΔDI MPC + MPS = 1

8. EXAMPLE A citizen from India, just got her Bachelors, and therefore will receive $1000 more this month. If her MPS is .2, how much money is put into Savings? What is her MPC, and how much money is spent?

9. EXAMPLE A citizen from India, just got her Bachelors, and therefore will receive $1000 more this month. If her MPS is .2: Savings: $200 (1000 X .2) MPC= 1 - .2 = .8 Consumption: $800

10. Determinants of C and S… 1) Expectations about Prices and Income 2) Interest Rates 3) Taxes 4) Wealth

11. EXPENDITURE PLANS An upward shift = more Consumption A downward shift = less consumption

12. How Does The Money Keep Rollin’ In? The Types of Multipliers: The Spending Multiplier = (1/MPS) The Investment Multiplier = (1/MPS) The Tax Multiplier = MPC X (1/MPS) *THE BIGGER MPC, THE BIGGER THE MULTIPLIER!

13. How much SCRILLA ROLLS in if… The Government of Argentina Spends $1,000  MPC: .75 Investment Increases by $1,000  MPC: .75 The Government Decreases Taxes by $1,000  MPC: .75

14. How much SCRILLA ROLLS in if… The Government of Argentina Spends $1,000  $1,000 X (1/.25) = $4,000 Investment Increases by $1,000  $1,000 X (1/.25) = $4,000 The Government Decreases Taxes by $1,000  $1,000 X .75 X 4 = $3,000

15. How does the AE Model Connect to the AD Model?

16. The Aggregate Expenditure Model Aggregate Expenditure = C + I + G+ NX Shows how Changes in I and G affect overall GDP/ Output/Income

17. The Effects of the Multiplier Using the Investment Multiplier