AP Macroeconomics
MPC, MPS, and
Multipliers
MPC & MPS
•
Marginal Propensity to Consume
–
% of every extra dollar earned that is spent
–
ΔC/ΔDI
•
Marginal Propensity to Save
–
% of every extra dollar earned that is saved
–
ΔS/ΔDI
•
MPC + MPS = 1
•
1
–
MPC = MPS
•
1
–
MPS = MPC
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
, G, X
N
)
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 defense
spending by $1 Billion, then defense
contractors will hire and pay more
workers, which will increase aggregate
spending by more than the original $1
Billion.
Calculating the Spending Multiplier
•
Multiplier =
Change in
AD or GDP
Change in
Spending
Desired change in GDP=change
in spending*multiplier
•
The Spending Multiplier can be calculated
from the MPC or the MPS.
•
Multiplier =
1
/
MPS OR
1
/
1

MPC
Putting it all together
•
Ex. Assume U.S. citizens spend 90¢ for every extra $1 of disposable
income they earn. Further assume that the real interest rate (r%)
decreases, causing a $50 billion increase in gross private investment.
Calculate the effect of a $50 billion increase in I
G
on U.S. Aggregate
Demand (AD).
–
Step 1: Calculate the MPC and MPS
•
MPC =
ΔC
/
ΔDI
=
.9
/
1
=
.9
•
MPS = 1
–
MPC =
.10
–
Step 2: Determine which Spending Multiplier to use.
•
Either 1/MPS OR 1/1

MPC
•
Step 3: Calculate the Spending Multiplier
•
1
/
MPS
=
1
/
.10
=
10
OR 1/1

MPC=1/1

.9=
10
–
Step 4: Calculate the Change in AD
•
(Δ C, I
G
, G, or X
N
) * Spending Multiplier
•
($50 billion Δ I
G
) * (10) =
$500 billion ΔAD
MPS, MPC, & Multipliers
•
Historically speaking, the Japanese are big savers. Let’s say
that for every extra dollar of disposable income they earn
they spend 25 cents. If they were each given a stimulus
check by how much would aggregate demand change
assuming the total stimulus was three billion dollars?
–
Step 1: Calculate the MPC and MPS
•
MPC =
ΔC
/
ΔDI
=
.20
/
1
=
.25
•
MPS = 1
–
MPC =
1

.25=.75
–
Step 2: Determine which multiplier to use.
•
Either 1/MPS OR 1/1

MPC
•
Step 3: Calculate the Spending Multiplier
•
1
/
MPS
=
1
/
.75
=
1.333
OR 1/1

MPC=1/1

.25=1.333
–
Step 4: Calculate the Change in AD
•
(Δ C, I
G
, G, or X
N
) * Spending Multiplier
•
($3 billion
Δ
DI)
*
(1.333)
=
$3.999 billion
ΔAD
Calculating the Spending Multiplier
•
1
/
MPS or 1/1

MPC
•
The
smaller
the fraction of any change in
income
saved
, the greater the
respending
at
each round and, therefore, the greater the
multiplier.
•
The larger the fraction of any change in
income spent, the greater the
respending
at
each round and, therefore the, the greater the
multiplier.
MPC & MPS
Review and Summary
•
Marginal Propensity to Consume
–
ΔC/ΔDI
–
% of every extra dollar earned that is spent
•
Marginal Propensity to Save
–
ΔS/ΔDI
–
% of every extra dollar earned that is saved
•
MPC + MPS = 1
•
1
–
MPC = MPS
•
1
–
MPS = MPC
MPC & MPS
Review and Summary
•
Multipliers (two to chose from)
•
1/1

MPC
•
1/MPS
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