[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

lion. If any of the components of E changes by $1, equilibrium output changes by
1/(1 − (1 − t)MPC). For example, suppose E increases to $4 trillion. Equilibrium output
rises to $15 trillion. The multiplier is equal to the change in output ($15 trillion −
$12.5 trillion = $2.5 trillion) per dollar change in E ($1 trillion), or 2.5. This can also
be found directly as 1/(1 − (1 − t)MPC) = 1/[1 − (1 − .25) × .8] = 2.5. By contrast, the multiplier
without taxes would be 1/(1 − MPC) = 5, or twice as large. The reason that
the multiplier is larger without taxes is simple. Without taxes, every dollar of extra
income translates into 80 cents of extra spending. With taxes, when income goes
up by a dollar, disposable income rises by 75 cents and consumption increases by
only .8 × .75 cents = 60 cents.
EXPECTATIONS OF FUTURE INCOME
Current disposable income is a key determinant of consumption, but households’ decisions
about how much to consume are also influenced by their expectations about
future income. If households expect that their income will fall in the future, they are likely
to reduce their current consumption so that they can save more. By saving more today,
they will be better able to preserve their standard of living when their income declines
later. Thus, a projected or expected tax increase that will reduce future disposable
income may reduce consumption spending even before it goes into effect. Conversely,
if households expect that their future income will rise, they are likely to increase their
consumption spending immediately. A projected or expected tax decrease can lead
to a rise in consumption before households actually see their disposable income go up.
The dependence of current spending on expectations about future income has
another very important implication. Households are likely to increase spending
more when their current income rises if they expect the income increase to be permanent—that
is, if they expect both their current and future income to be higher.
Similarly, a tax cut viewed as temporary is likely to lead to a smaller increase in consumption
than a tax cut that is viewed as permanent. Another way to express this
implication is to say that the marginal propensity to consume out of permanent
changes in income will be larger than the marginal propensity to consume out of
temporary or transitory changes in income.
If consumption changes when expected future income changes, even when current
income is still the same, then shifts in expectations will cause the aggregate
expenditure schedule to shift. When households become more optimistic about their
future income, aggregate consumption will increase at each level of current disposable
income. The result is an increase in aggregate expenditures at each level of
national income, shifting the aggregate expenditure schedule upward.
WEALTH
A third factor that is important for determining consumption is household wealth.
Wealthier households will consume more (at each level of current income). Just as
changes in individuals’ wealth will affect their consumption choices, so changes in
aggregate wealth will affect aggregate consumption.
CONSUMPTION ∂ 671