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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]
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
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