Untitled Flashcards Set

1. What is disposable income, and how is it calculated?

Disposable income is the income remaining after personal taxes are paid, available for

consumption or saving.

Income -Taxes

2. How does the consumption function relate to income levels?

The consumption function describes the relationship between consumption spending and

disposable income in an economy.

3. What happens when a household dis-saves? Provide an example.

When a household dis-saves, it spends more than its current income by

borrowing, using past savings, or selling assets

4. If a person earns $50,000 and spends $40,000, what is their APC and APS?

APC = Consumption / Income = $40,000 / $50,000 = 0.80

APS = Saving / Income = (Income - Consumption) / Income = ($50,000 - $40,000) /

$50,000 = 0.20

5. Explain how marginal propensity to consume (MPC) and marginal propensity to

save (MPS) differ from APC and APS.

MPC and MPS measure how individuals allocate changes in income between

consumption and saving, while APC and APS measure the total proportion of income

spent or saved.

6. What is the multiplier effect, and how does it impact GDP?

The multiplier effect refers to how an initial change in spending leads to a larger overall

change in GDP.

7. How is the spending multiplier calculated?

Multiplier = 1 / MPS

or Multiplier = 1 / (1 - MPC)

8. If investment spending increases by $3 billion and the multiplier is 5, what is the

change in GDP?

Change in GDP = Multiplier × Change in Investment Spending

5 × $3 billion = $15 billion.

9. What are the main sources of changes in spending in an economy?

consumption, investment, government spending, and net exports

10. How does a decrease in spending affect GDP through the multiplier effect?

A decrease in spending leads to a multiplied decrease in GDP, as the initial

reduction in expenditures reduces income, which then lowers consumption

and further decreases total economic output.

11. Why is investment spending considered volatile?

Investment spending is considered volatile because it is highly sensitive to the

business cycle, changes in interest rates, business expectations, technological

advancements, and economic conditions

12. How does one person’s spending become another person’s income?

When an individual purchases goods or services, the money spent goes to businesses

or workers, who then receive it as wages, profits, or revenue, continuing the cycle of

economic activity.

13. What are the formulas for calculating the multiplier using MPS and MPC?

1/MPS or 1/1-MPC

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14. If MPS is 0.25, what is the value of the spending multiplier?

Given that MPS = 0.25, the spending multiplier is:

1/.25 = 4

15. How does the size of MPC affect the size of the multiplier?

The higher the Marginal Propensity to Consume (MPC), the larger the multiplier,

because more spending circulates through the economy, while a lower MPC results

in a smaller multiplier due to more saving and less re-spending.

16. What external factors affect the real-world U.S. spending multiplier?

Taxes – Higher taxes reduce disposable income

Interest Rates – Higher interest rates discourage borrowing and investment, reducing the

impact of spending increases.

Consumer Confidence – If consumers are uncertain about the economy, they may save

more rather than spend, lowering the multiplier.

Government Policies – Fiscal policies like stimulus programs or spending cuts directly

affect aggregate demand and the multiplier.

17. If a country’s total disposable income increases from $200 billion to $250 billion,

and consumption increases from $160 billion to $200 billion, calculate the

Marginal Propensity to Consume (MPC) and the Marginal Propensity to Save

(MPS).

250−200=50 billion

200−160=40 billion

40/50 + 0.8

1-.8 +0 .2

18. Suppose a household's disposable income rises from $30,000 to $40,000, and its

consumption increases from $24,000 to $32,000. Compute the MPC and MPS.

40,000−30,000=10,000

32,000−24,000=8,000

MPC= 8000/10,000 =0.8

MPS=1−0.8=0.2

19. A consumer earns $75,000 per year and spends $60,000 on goods and services.

Determine their APC and APS.

APC = 60,000/75000 =0.8

������ = 1 − 0.8 = 0.2

20. The government provides a stimulus payment of $1,200 to a household, which

leads to an increase in consumption of $900. Calculate the MPC and MPS, then

determine the Spending Multiplier.

MPC = $900 / $1,200 = 0.75

MPS = 1 - 0.75 = 0.25

Spending Multiplier = 1 / MPS = 1 / 0.25 = 4

21. A country has an MPC of 0.75. Calculate the Spending Multiplier and explain

what this means in terms of total spending in the economy.

Spending Multiplier = 1 / (1 - 0.75) = 1 / 0.25 = 4

Interpretation: Every $1 of new spending generates an additional $4 in total economic

activity due to repeated rounds of spending.

22. Suppose a government implements a tax cut that increases disposable income

by $500 billion, and consumers increase their spending by $350 billion.

Determine the MPC, MPS, and the Spending Multiplier.

MPC = $350B / $500B = 0.70

MPS = 1 - 0.70 = 0.30

Spending Multiplier = 1 / MPS = 1 / 0.30 =3.33