Chapter 9 Average Propensity to Consume (APC) = Consumption/Income Average Propensity to Save (APS) = Saving/Income Marginal Propensity to Consume (MPC) = ? Consumption/ ? Income Marginal Propensity to Save (MPS) = ? Saving/ ? Income The investment decision is a marginal-benefit-marginal-cost decision: The marginal benefit from investment is the expected rate of return businesses hope to realize. The marginal cost is the interest rate that must be paid for borrowed funds. Multiplier determined how much larger that change will be Multiplier = Change in real GDP/Initial change in spending Change in GDP = Multiplier X Initial change in spending Multiplier = 1/ (1-MPC) or 1/MPS **The higher the marginal propensity to CONSUME, the larger the multiplier Direct relationship between changes in spending and change sin real GDP. But a change in spending, say, investment, ultimately changes output and income by more than the initial change in investment spending, and that is called multiplier effect. Rationale ? Two facts. The economy supports repetitive, continuous flows of expenditures and income. Any change in income will vary both consumption and saving in the same direction and by a fraction of the change in income
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