Aggregate Supply and Demand

Chapter 27

Expenditure Multipliers Fixed Prices and Expenditure Plans

• • • • • • • • • • • • • • • • Several factors influence consumption expenditure and saving. The most direct influence is disposable income, which is real GDP or aggregate income minus net taxes (taxes minus transfer payments). Planned consumption expenditure plus planned saving equals disposable income. The greater the disposable income, the greater is consumption expenditure and the greater is saving. The relationship between consumption expenditure and disposable income, other things remaining the same, is called the consumption function. The relationship between saving and disposable income, other things remaining the same, is called the saving function. The extent to which a change in disposable income changes consumption expenditure depends on the marginal propensity to consume. The marginal propensity to consume (MPC) is the fraction of a change in disposable income that is consumed. The marginal propensity to consume is calculated as the change in consumption expenditure ΔC, divided by the change in disposable income, ΔYD. That is: MPC = ΔC ÷ ΔYD The extent to which a change in disposable income changes saving depends on the marginal propensity to save. The marginal propensity to save (MPS) is the fraction of a change in disposable income that is saved. The marginal propensity to save is calculated as the change in saving ΔS, divided by the change in disposable income, ΔYD. That is: MPS = ΔS ÷ ΔYD The marginal propensity to consume plus the marginal propensity to save sum to 1. You can see this from the following: C + S = YD ΔC + ΔS = ΔYD (ΔC ÷ ΔYD) + (ΔS ÷ ΔYD) = (ΔYD ÷ ΔYD) MPC + MPS = 1

• •

The figure below shows the MPC as the slope of the consumption function. MPC is $150 billion ÷ $200 billion = 0.75.

• •

The figure below shows the MPS as the slope of the saving function. MPS is $50 billion ÷ $200 billion = 0.25.

The relationship between imports and real GDP is...