AP Macroeconomics

Fun!!! With the

MPC, MPS, and
Multipliers

Disposable Income

Net Income
Paycheck
After-tax income

Marginal Propensity to
Consume (MPC)
The fraction of any change in
disposable income that is
consumed.
MPC= Change in Consumption
Change in Disposable
Income
MPC = C/DI

Marginal Propensity to
Save (MPS)
The fraction of any change in
disposable income that is saved.
MPS= Change in Savings
Change in Disposable
Income
MPS =

/DI

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!

The Spending Multiplier

Effect

Why does this

happen?

Expenditures and income

flow continuously which
sets off a spending
increase in the economy.
Read pg. 199

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.

Calculating the Spending

Multiplier
The Spending Multiplier can be
calculated from the MPC or the
MPS.
Multiplier =

/1-MPC or

/MPS

Multipliers are (+) when there

is an increase in spending and
() when there is a decrease

Calculating the Tax

Multiplier

When the government taxes, the multiplier

works in reverse
Why?
Because now money is leaving the circular flow

Tax Multiplier (note: its negative)

= -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

MPS, MPC, & Multipliers

Ex. Assume U.S. citizens spend 90 for every extra $1
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) or AE.
Step 1: Calculate the MPC and MPS
MPC = C/DI = .9/1 = .9
MPS = 1 MPC = .10
Step 2: Determine which multiplier to use, and whether its +
or The problem mentions an increase in I G .: use a (+)
spending multiplier
Step 3: Calculate the Spending and/or Tax Multiplier
1/MPS = 1/.10 = 10
Step 4: Calculate the Change in AD/AE
( C, IG, G, or XN) * Spending Multiplier
($50 billion IG) * (10) = $500 billion AD/AE

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 = 1 - .25 = .75
Step 2: Determine which multiplier to use, and whether its +
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
( Tax) * Tax Multiplier
(200 billion T) * (-3) = -600 billion in AD/AE

MPS, MPC, & Multipliers

Ex. Assume the Japanese spend 4/5 of their disposable income.
Furthermore, assume that the Japanese government increases its
spending by 50 trillion and in order to maintain a balanced
budget simultaneously increases taxes by 50 trillion. Calculate
the effect the 50 trillion change in government spending and
50 trillion change in taxes on Japanese Aggregate Demand or
AE.
Step 1: Calculate the MPC and MPS
MPC = 4/5 (given in the problem) = .80
MPS = 1 MPC = 1 - .80 = .20
Step 2: Determine which multiplier to use, and whether its + or The problem mentions an increase in G and an increase in T .:
combine a (+) spending with a () tax multiplier
Step 3: Calculate the Spending and Tax Multipliers
Spending Multiplier = 1/MPS = 1/.20 = 5
Tax Multiplier = -MPC/MPS = -.80/.20 = -4
Step 4: Calculate the Change in AD
[ G * Spending Multiplier] + [ T * Tax Multiplier]
[(50 trillion G) * 5] + [(50 trillion T) * -4]
[
250 trillion
]+[
- 200 trillion
] = 50 trillion
AD/AE

The Balanced Budget

Multiplier
That last problem was a pain, wasnt it?
Remember when Government Spending
increases are matched with an equal
size increase in taxes, that 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

Does a change in G
have the same effect
on GDP as a change in
No G hasT?
a greater effect!

A change in G affects GDP

directly by a multiple of the
change in G.
A change in T affects GDP by a
multiple of less than the change
in T.
A change in T results in a change in Yd. Yd
can be either spent (C) or saved (S);
therefore, a change in T only affects GDP

Determine the effect on GDP of an

increase in G of $20 billion and the
effect of a decrease in T of $20
billion. Assume the MPC = .80
1/1-.80 = _____
5
Multiplier = _________

Effect of the the increase in G:

20
5
100 increase
_____
X ______
= ______

Effect of the decrease in T:

20 _____
16 C _____
4 S
T of $20 billion Yd _____
16
_____

5
80 increase which is less than
X ______
= ______
The increase of 100 from G.

What would be the effect on the

economy (GDP) of a decrease of $100
billion in G. Assume the MPS =.25
100 X 4 = $400 billion decrease in GDP

What would be the effect of an increase in taxes of $100 billion?

Increase T of $100 billion decreases income (Yd) by

100 billion. That means consumers will decrease spending
by $75 billion (.75 x100) and decrease saving by $25 bill.
The $75 billion decrease in C X the multiplier of 4 = a $300
Billion decrease in GDP.

Determine the effect on GDP of equal

increases (balanced budget) in both
G and T of $50 billion. Assume an
MPC of .80.
Effect on Budget?
balanced
Effect on GDP (economy)?
Increase by $50 billion
$40 billion
Multiplier =5_____
(.80x50)
C=
_____
Effect of G: 5 x 50 = 250 billion increase in GDP
Effect of T: decrease income by $50 billion; therefore,
C decreases by $40 billion and S decreases by $10 billion.
Therefore, $40 billion X 5 = 200 billion decrease in GDP
Net effect: 250 200 = $50 billion increase in GDP

Key Idea: The balanced

budget multiplier is 1 x
G
An increase in G and T of $50 billion would
increase GDP by how much? ________
50 billion

A decrease in G and T of $30 billion would

decrease GDP by how much? _______
$30 billion
Conclusion: A balanced budget increase in G
and T (spending and taxes are equal) has an
____________ effect on the economy.
A balanced
budget decrease in spending and
expansionary
taxes has an ______________ effect on the
budget.
contractionary

Spending Multiplier
Formulas:
M = 1/MPS or 1/1-MPC or GDP/ AE
If the MPS = .20

.80
the MPC = ____

5
M = ____

If the MPC = .75

the MPS = ____

.25 M = ____
4

If the MPC = .90

the MPS = ____ M = ____

.10

10

If the change in GDP = $20 billion and the

change in AE = $5 billion, then the multiplier
= ____ and the MPC = _____ and the MPS =
_____.

4
.25

.75

Key Formula: AE x M =
GDP
M = 1/MPS or 1/1-MPC or GDP/ AE

If the GDP gap is $100 billion,

how much must AE (C, I, G, or
Xn) increase to return the
economy to YF if the MPC = .80?
5
M = 1/1-MPC = 1/1-.80 = 1/.20 = _____

AE x M = GDP
20
5
______
X ______
= 100 Billion

Key Formula: AE x M =
GDP
M = 1/MPS or 1/1-MPC or GDP/ AE

If the GDP gap is $40 billion and

the MPS = .25, what amount must
AE increase to close the GDP gap?
4
M = 1/MPS = 1/.25 = _____

AE x M = GDP
10
______
X

4
______
= 40 Billion

Key Formula: AE x M =
GDP
M = 1/MPS or 1/1-MPC or GDP/ AE

If the economy is in a recession

and has a GDP gap of $50 billion,
how much must government
increase G to close the GDP gap
and return to full employment,
5
M = 1/MPS
= 1/.20
= _____
assuming
an MPS
of .20?

AE x M = GDP

10
______
X

5
______
= 50 Billion

If $500 billion in AE $1000

billion in GDP, then how
much would G have to to
reach a YF of $2000 billion?
$2000B
$1000B
$500B
$200B
$100B

Explanation:
1000/500 = 2 = Multiplier =
GDP/AE
AE x Multiplier = GDP
G x 2 = 2000
G = 1000

The value of the spending

multiplier decreases when?
A. Tax rates are
decreased
B. Exports decrease
C. Imports decrease
D. Government
expenditures
decrease
E. The MPS increases

The multiplier =
1/MPS
1/.20 = 5
1/.40 = 2.5
As MPS increases,
the
multiplier decreases.

Which of the following best

explains why equilibrium
income will rise by more than
$100 in response to a $100
A. Incomes will taxes
increase in G?
Multiplier effect
Spending becomes
Income which is either
AE PL
Spent or saved; the
New expenditure gives
D. AE MS I
rise to more income,
which leads to more
E. budget deficit AE spending.. . .

B. Incomes will C

In a closed economy with no

taxes in which the APC is 0.75,
which of the following is true?
APC = fraction of income spent = .75 = 3/4ths

A. If income is $100, then saving is

$75
B. If income is $100, then C is $50
C. If income is $200, then saving is
$50
D. If income is 200, then C is $75
.75 = $150 in consumption, leaving $50 in saving.
E. 200
If xincome
is $500, then S is $100

Suppose that Yd is $1000, C is

$700, and the MPC is 0.60. If
Yd increases by $100, C and S
C will
_ Sequal which of the
A. 420 280following?
YD = 1000
B. 600
C. 660
D. 660
E. 760

400
320
440
340

C = 700
S = 300 as a starting point
Yd = 100 and MPC = .60
C = .60 (100) = 60 and
S = .40 (100) = 40
700 + 60 = 760 C
300 + 40 = 340 S

If at YF, government wants to

increase its spending by $100
billion without inflation in the
short run, it must do which of
T by greater than $100 B
the following?

T by $100B
G has a greater effect
T by less than $100
on B
GDP than T; therefore the T must be
T by $100 B
Greater than the G to
by less than $100 B
offset the increased G
and prevent further
Inflation.

If AE from 200 to 300 solely

due to a change in G leads
which leads to a change in GDP
of 1000 to 1500, which of the
following is true? G = 100
A. G is 300 and the multiplier is 5 GDP =
500
B. G is 100 and the multiplier is 5
M=5
C. G is 100 and C increases by 500
D. G and GDP increase by 500 each
E. C and GDP increase by 500 each