Transcript Mr. Mayer AP Macroeconomics

MPC, MPS, and
Multipliers
• Any increase in spending will result in an
even larger increase in GDP due to the
fact that every dollar spent is spent again
multiple times.
• Any money spent is someone else’s
income and therefore subject to spending.
Decisions to Save and Spend
• How strong the multiplier effect will be is
determined by our decisions to save and
spend.
• As our income changes we will spend a
portion and save a portion of this change.
Marginal Propensity to
Consume
• The portion we spend is known as our
Marginal Propensity to Consume (MPC)
• It is found by dividing the change in
Consumption by the change in Disposable
Income
• For example if we receive a $10 an hour
raise and we spend $9 of it and save $1,
then our MPC is .9
C/
DI = MPC so 9/10 = .9
Marginal Propensity to Save
• The portion we save is known as our
Marginal Propensity to Save (MPS)
• It is found by dividing the change in
Savings by the change in Disposable
Income
• For example if we receive a $10 an hour
raise and we spend $9 of it and save $1,
then our MPS is .1
S / DI = MPS so 1/10 = .1
• The MPC + MPS is always equal to 1
• The limiting factor for the multiplier effect
is savings.
• For every additional dollar spent a portion
of it will be saved (the MPS).
• The multiplier is the reciprocal of the MPS
or 1/MPS or 1/1- MPC.
• The larger the MPC (the smaller the MPS)
the larger the multiplier will be.
Spending Multiplier = 1/MPS
MPC
.90
.80
.75
.60
.50
1/MPS
1/.10
1/.20
1/.25
1/.40
1/.50
= M
= 10
=
5
=
4
= 2.5
=
2
The First Round of Government
Spending Causes The Biggest Splash
MPC of 75%
G spends $200 billion on the highways.
Highway workers save 25% of $200 billion [$50
billion] & spend 75% or $150 billion on boats.
Boat makers save 25% of $150 bil. [$37.50 bil.]
& spend 75% or $112.50 bil. on iPod Minis, etc.
Total Saving has reached $87.50
USING MULTIPLIERS
• The multiplier can be used to calculate
how any change in spending will change
total spending (AD) or income (GDP).
• The formula used is: Change in
Spending x Multiplier = Change in
AD/GDP.
• Ex: G $1b x 4 = $4b in AD/GDP
USING MULTIPLIERS
• Since any change in GDP is the result of
the change in spending x multiplier, you
can find the multiplier by dividing the
change in AD/GDP by the change in
spending.
• Ex: $4b AD/GDP /
multiplier of 4
$1b in G =
USING MULTIPLIERS
• Knowing that any change in spending will
have a multiplied effect government can
calculate how much to change spending
by dividing the needed change in GDP
by the multiplier.
• Ex: GDP is $4b below full employment
$4b needed / 4 = $1b
in G
• A change in taxes also has a
multiplied effect, but the tax
multiplier is smaller than the
spending multiplier.
• Tax Multiplier (note: it’s negative
because tax increases reduce
spending)
-MPC/
or MPC/
1-MPC
MPS
• If there is a tax-CUT, then the
multiplier is +, because there is now
more money in the circular flow
Tax Multiplier = -MPC/MPS
MPC
.90
.80
.75
.60
.50
= M
-MPC/.10=
-9
-MPC/.20=
-4
-MPC/.25=
-3
-MPC/.40= -1.5
-MPC/.50=
-1
MPC/MPS
Spending Multiplier
= 1/MPS
Multiplier
MPC
.9
5
.75
4 -3
Tax Multiplier
-9
10
.8
Tax Multiplier = -MPC/MPS
-4
.60 2.5 -1.5
.5
2 -1
The tax multiplier is always smaller than the
spending multiplier because a portion of the
change in income due to taxes is saved, reducing
the overall impact on spending.
The Balanced Budget Multiplier
• When government spending increases are
matched with equal size increases in taxes,
the change ends up being = to the change in
government spending
• Why?
• 1/MPS + -MPC/MPS = 1- MPC/MPS = MPS/MPS = 1
• The balanced budget multiplier always = 1
Multiplier Practice
• Assume US citizens spend $.90 for every
extra $1 they earn.
• Further assume that the real interest rate
(i) decreases, causing a $50 billion
increase in Investment (I).
• Calculate the effect of this increase in
spending on AD.
Step 1: Calculate the MPC and MPS
MPC = C / DI
MPS = 1- MPC =
Step 2: Determine which multiplier to use, and
whether its + or –
The problem mentions an increase in I, use a (+)
spending multiplier
Step 3: Calculate the Spending and/or Tax
Multiplier
Step 4: Calculate the Change in AD
(
C, I, G or NX) * Spending or Tax Multiplier
More Practice
• Assume Germany raises taxes on its
citizens by 200b.
• Assume that Germans save 25% of the
change in their disposable income.
• Calculate the effect of these taxes on the
German economy.
More Practice
• Assume the Japanese spend 4/5 of their
disposable income.
• Assume that the Japanese government
increases its spending by 50 trillion and
in order to maintain a balanced budget
simultaneously increase taxes by 50t.
• Calculate the effect of these changes on
the Japanese Aggregate Demand.