1. MPC, MPS, and Multipliers
AP Macroeconomics
MPC, MPS, and Multipliers

3. “We are what we repeatedly do
“We are what we repeatedly do. Excellence, then, is not an act but a habit.” ~ Aristotle

4. Disposable Income
Net Income
Paycheck
After-tax income

5. The Spending Multiplier Effect
An initial change in spending (C, IG, G, XN) causes a larger change in aggregate spending, or Aggregate Demand (AD).
We are going to calculate the total change in GDP given a change in C, Ig, G, and/or Xn

6. The Spending Multiplier Effect
Why does this happen?
Expenditures and income flow continuously which sets off a spending increase in the economy.

7. AVERAGE Propensity to Consume/Save
The APC and APS is the percentage of disposable income that is consumed and saved
There are only two things you can do with DI. Save or consume it.
Given that the Japanese are big savers. Do they have a low or high APC?
Given that Americans are big consumers do we have a low or high APS?

8. MPC & MPS Marginal Propensity to Consume Marginal Propensity to Save
% 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
Because you can only save or consume. What you are NOT saving you are consuming
What you are not consuming you are saving therefore MPC+MPS must equal 1 (100% of disposable income has been accounted for)

9. 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!

10. 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.

11. Calculating the Spending Multiplier
The Spending Multiplier can be calculated from the MPC or the MPS.
Multiplier = 1/MPS OR 1/1-MPC
Change in spending*multiplier=change in GDP
Spending=changes in C, Ig, G, or Xn

12. Scenario
You want to produce 50 apples by the end of October Each tree you plant will give you 5 apples. How many trees do you need to plant in the spring of 2014?
Well, 50 divided by what will equal 5?
That’s right, 10

13. 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 IG 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-MPC
Step 3: Calculate the Spending Multiplier
1/MPS = 1/.10 = OR 1/1-MPC=1/1-.9=10
Step 4: Calculate the Change in AD
(Δ C, IG, G, or XN) * Spending Multiplier
($50 billion Δ IG) * (10) = $500 billion ΔAD

14. 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 = .25/1 = .25
MPS = 1 – MPC = 1-.25=.75
Step 2: Determine which multiplier to use.
Either 1/MPS OR /1-MPC
Step 3: Calculate the Spending Multiplier
1/MPS = 1/.75 = OR 1/1-MPC=1/1-.25=1.333
Step 4: Calculate the Change in AD
(Δ C, IG, G, or XN) * Spending Multiplier
($3 billion Δ DI) * (1.333) = $3.999 billion ΔAD

15. Calculating the Spending Multiplier
1/MPS or /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.

16. 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

17. MPC & MPS Review and Summary
Multipliers (two to chose from)
1/1-MPC
1/MPS

18. “Failure is simply the opportunity to begin again, this time more intelligently.” ~ Henry Ford

19. Calculating the Tax Multiplier
When the government increases taxes, the multiplier works in reverse
Why?
Because now money is leaving the circular flow
Tax Multiplier (note: it’s negative if taxes increase)
= -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

20. MPS, MPC, & Multipliers
Ex. Assume Germany raises taxes on its citizens by €200 billion . Furthermore, assume that Germans save 25% of the change in their disposable income. Calculate the effect the €200 billion change in taxes on the German economy.
Step 1: Calculate the MPC and MPS
MPS = 25%(given in the problem) = .25
MPC = 1 – MPS = = .75
Step 2: Determine which multiplier to use, and whether it’s + or -
The problem mentions an increase in T .: use (-) tax multiplier
Step 3: Calculate the Spending and/or Tax Multiplier
-MPC/MPS = -.75/.25 = -3
Step 4: Calculate the Change in AD
(Δ Tax) * Tax Multiplier
(€200 billion Δ T) * (-3) = -€600 billion Δ in AD

21. Change in G vs. Change in T
A change in government transfers or taxes shifts the aggregate demand curve by LESS than an equal-sized change in G. Why? Two reasons
First, what are transfer payments?
Unemployment compensation, Medicare, Medicaid
Transfer payments do not count as G so it doesn’t count towards GDP

22. Change in G vs. Change in T
Because the transfer payment itself does not count as an increase in G. We have to spend some of the money to see any change on AD. However a change in G itself immediately changes AD.
People will save at least a portion of their transfer or tax cut.