econ ala 20

Introduction to Disposable Income

  • Disposable Income: The income left after paying taxes.
    • For simplification, assume taxes equal zero, hence Disposable Income = Income.
  • Expenditure of Disposable Income: Two main options.
    1. Save
    2. Spend on Consumption

Marginal Propensity Concepts

  • Marginal Propensity to Consume (MPC): The fraction of each additional dollar earned that is spent on consumption.

    • Mathematical Representation:
    • extMPC=extChangeinConsumption(rianglec)extChangeinIncome(riangley)ext{MPC} = \frac{ ext{Change in Consumption} ( riangle c)}{ ext{Change in Income} ( riangle y)}
    • Example:
    • Suppose a person receives $200 and spends $150 on a smartphone.
    • Change in income: $200
    • Change in consumption: $150
    • Calculation:
      • extMPC=150200=0.75ext{MPC} = \frac{150}{200} = 0.75
    • This indicates that the individual will spend 75% of each additional dollar earned.

  • Marginal Propensity to Save (MPS): The fraction of each additional dollar earned that is saved.

    • Mathematical Representation:
    • extMPS=extChangeinSavings(riangleS)extChangeinIncome(riangleY)ext{MPS} = \frac{ ext{Change in Savings} ( riangle S)}{ ext{Change in Income} ( riangle Y)}
    • Example:
    • From the previous case:
    • Change in savings: $50
    • Calculation:
      • extMPS=50200=0.25ext{MPS} = \frac{50}{200} = 0.25
    • This indicates that the individual will save 25% of each additional dollar earned.

Variability of Marginal Propensities

  • Cultural Differences: Marginal propensities to consume and save vary between countries.
    • Japan vs. United States:
    • Example highlights a lower MPC in Japan compared to the United States.

Example Calculation for Marketopia

Change in Income and Consumption

  • Income Change:
    From: $390,000,000,000 to $400,000,000,000

    • riangleY=400,000,000,000−390,000,000,000=10,000,000,000riangle Y = 400,000,000,000 - 390,000,000,000 = 10,000,000,000

  • Consumption Change:
    From: $342,000,000,000 to $350,000,000,000

    • riangleC=350,000,000,000−342,000,000,000=8,000,000,000riangle C = 350,000,000,000 - 342,000,000,000 = 8,000,000,000

  • Savings Change:
    From: $48,000,000,000 to $50,000,000,000

    • riangleS=50,000,000,000−48,000,000,000=2,000,000,000riangle S = 50,000,000,000 - 48,000,000,000 = 2,000,000,000

Marginal Propensity Calculation

  • Sum of Changes Verification:

    • Change in consumption and savings should add up to the change in income:
    • riangleC+riangleS=8,000,000,000+2,000,000,000=10,000,000,000riangle C + riangle S = 8,000,000,000 + 2,000,000,000 = 10,000,000,000

  • Calculating MPC:

    • extMPC(Marketopia)=8,000,000,00010,000,000,000=0.8ext{MPC (Marketopia)} = \frac{8,000,000,000}{10,000,000,000} = 0.8
    • Interpretation: Marketopia residents will spend 80% or $0.80 of each additional dollar earned.

  • Calculating MPS:

    • extMPS(Marketopia)=2,000,000,00010,000,000,000=0.2ext{MPS (Marketopia)} = \frac{2,000,000,000}{10,000,000,000} = 0.2
    • Interpretation: Marketopia residents will save 20% or $0.20 of each additional dollar earned.

Relationship Between MPC and MPS

  • Summation Property:
    • The sum of MPC and MPS equals one.
    • This can be represented as:
    • extMPC+extMPS=1ext{MPC} + ext{MPS} = 1
  • Understanding the Relationship:
    • Since a fraction of each dollar earned is either consumed or saved, the total must represent the whole dollar.

Conclusion on Economic Expenditures

  • Key Models:
    • MPC and MPS are integral models that help determine how expenditures change in response to changes in income.
  • Implications:
    • Understanding these concepts is crucial for analyzing consumer behavior and economic policy decisions.