Consumption & SavingsMPC & MPS

Disposable Income (DI)

• Disposable Income (DI) = Gross Income – Net Taxes• Disposable Income = income after paying taxes

• Gross income = income before taxes

• Net taxes = Taxes paid – Gov’t transfer payments received

• You have 2 choices with income: Consume or Save

– DI = Consumption + Savings

DISPOSABLE INCOME

HOUSEHOLDSFIRMS

Consumption [C]

Savings [S]

Consumption & Savings are functions of DI

If DI ↑ C S&

Consumption & Savings Function

Is the minimum amount of consumption regardless of income

At low levels of income, savings can be negative!

Autonomous Consumption (a)

C = a + MPC(DI)

S = -a + MPS(DI)

Marginal Propensity to Consume

• MPC = Slope of the consumption function

MPC = ∆C / ∆ DI

. .

DI ↑

C ↑

Consumption Function

Marginal Propensity to Save(MPS)

• MPS = Slope of the saving function

MPS = ∆S / ∆ DI

DI ↑ $1,000 => Savings ↑ $400

If MPS = .40

MPC + MPS = 1

• MPC + MPS = 1 Must be true because everything not saved is consumed:

DI = C + S

fraction income savedfraction income consumed

MPS = .40

MPC = .60

So if DI ↑ $2,000

Savings =>

Consumption =>

Shifts in Consumption & Savings

• A change in disposable income cause movements along curve– that means no shift!

• Shifts are caused by change in determinants of savings/consumption– C & S generally must shift in opposite directions

Determinants of Consumption & Savings

• Changes in these 4-factors cause shift in both functions– Wealth

– Expectations

– Household Debt

– Taxes & Transfers • Only time each curve shifts

in same direction

MPC/MPS Worksheet

MPS = .40

MPC = .60MPC = .60