Question

You are given the following information about the economy of Australia. $$\begin{array}{cc} \text { Disposable income } & \text { Saving } \\ \hline \text { [billions of dollars per year) } \\ \hline 0 & 0 \\ 100 & 25 \\ 200 & 50 \\ 300 & 75 \\ 400 & 100 \end{array}$$ Calculate the marginal propensity to save.

Short answer

The Marginal Propensity to Save is 0.25.

Step-by-step solution

- Define Marginal Propensity to Save (MPS)

Marginal Propensity to Save (MPS) is the fraction of an additional amount of disposable income that is saved. It is calculated as the change in saving divided by the change in disposable income.

- Identify Changes in Disposable Income

From the data, as disposable income increases from 0 to 100, 100 to 200, 200 to 300, and 300 to 400, the consistent change in disposable income each time is 100 billion dollars.

- Identify Changes in Saving

From the data, as disposable income increases from 0 to 100, 100 to 200, 200 to 300, and 300 to 400, the consistent change in saving each time is 25 billion dollars.

- Apply the Formula for MPS

MPS can be calculated using the formula: \[ MPS = \frac{\Delta S}{\Delta Y} \] where \( \Delta S \) is the change in saving and \( \Delta Y \) is the change in disposable income.

- Insert Values and Calculate MPS

Insert the identified changes into the formula: \[ MPS = \frac{25 \text{ billion dollars}}{100 \text{ billion dollars}} = 0.25 \]

Key concepts

Disposable Income

Disposable income is the amount of money that households have available for spending and saving after taxes have been accounted for. It is crucial in determining how people make economic decisions.

Think of it this way: if you receive a paycheck, the total amount you get paid is your gross income. After paying all the taxes that are deducted before the money gets to you, what you finally have in hand to spend is your disposable income.

Understanding disposable income is important because:

• It determines how much people can actually spend on goods and services.
• It influences saving behavior. Higher disposable income can lead to more savings.
• It has a direct impact on the economy, as consumer spending drives economic growth.

In the given exercise, disposable income data ranges from 0 to 400 billion dollars per year, which helps in calculating the Marginal Propensity to Save.

Saving

Saving refers to the portion of disposable income that is not spent on consumption of goods and services. It represents delayed consumption and is an important factor for future financial security.

Savings can take various forms, such as bank deposits, investments in stocks, or contributions to retirement funds. Savings play a significant role in the economy by providing funds for investment, which promote economic growth.

In the context of the exercise:

• Savings increase as disposable income rises.
• The relationship between disposable income and saving helps us calculate the Marginal Propensity to Save, a measure of how much additional income is saved rather than spent.
• The given data indicates a consistent increase in savings by 25 billion dollars for every 100 billion dollars increase in disposable income.

Economic Formulas

Economic formulas are essential tools to quantify relationships and understand patterns in economics. The formula used in this exercise is for Marginal Propensity to Save (MPS).

MPS measures the fraction of additional income that a household saves. Mathematically, it is defined as:

\[\begin{equation}MPS = \frac{\Delta S}{\Delta Y}\end{equation}\]where:

• \( \Delta S \) represents the change in saving.
• \( \Delta Y \) represents the change in disposable income.

This formula tells us how much of every additional dollar of disposable income is saved by households instead of being spent.

In the exercise, you observed the changes in saving and disposable income:

• Change in Saving (\( \Delta S \)) = 25 billion dollars.
• Change in Disposable Income (\( \Delta Y \)) = 100 billion dollars.

Applying these values to the formula, we calculated MPS as:

\[\begin{equation}MPS = \frac{25 \text{ billion dollars}}{100 \text{ billion dollars}} = 0.25\end{equation}\]Knowing this helps in understanding saving behavior and predicting future economic activity.