Students Again

According to some, MPC (Marginal Propensity to Consume) and MPS (Marginal Propensity to Save) are related ideas. Show how the following must be true in a closed economy (no government, no international):

The S curve crosses the "zero" line at the same income level that Y = C. Why does it just happen to be that C would be exactly equal to Y at that point?

Y= total disposable income
C = total consumption
Y = C + S

At this point S = $0 and Y = C. All the disposable income available was used as consumption and no savings occurred.

MPC < 1 and also that MPS < 1

1 = MPC + MPS; since the equation calls for the addition of MPS and MPC to be equal to 1, both variables have to be less than 1.

A $10 B increase in G causes more than a $10 B increase in GDP. Where does the rest of the money come from?

Government spending is subject to the multiplier. If the government increased spending by $10B, the $10B is subject to the multiplier. Let’s say that the multiplier is 2, then the GDP will increase by ($10B * 2) $20B.

If government takes $10 B away from you in taxes - and then turns around and spends that $10 B as additional G - it should all balance out - right? Why then does GDP rise?

Since “G” is subject to the multiplier, the “G” that is added to GDP is ($10B * multiplier). If the MPC is .60, the $10B taxes will lower the “C” by (.60*$10B) $6B. If the MPS is .40, the $10B is taxes will lower the “S” by (.40 *$10B) $4B. There is a $6B decline in  consumption, not $10B. This decline is also subject to the multiplier ($6B * multiplier).

The GDP equation calls for: GDP = C + I + X + G, the “C” is reduced by $6B while “G” increase by ($10B * multiplier). According to the equation for GDP, since consumption was reduced by a much lower amount than government spending the GDP rises even though the dollar amount of taxes and government spending was the same.