Question #140422
Explain why the sum of MPC and MPS equals to 1.
Consider an individual consumption function, which is the standard textbook consumption function, that is, has a y-intercept of autonomous consumption and is linear in the disposable income. Assume that the slope of this consumption function equals 0.7, and that the autonomous consumption equals $20 billion in the aggregate economy.
a. Write down the consumption function for this economy.
b. What is the marginal propensity to save (MPS) in this example?
c. Suppose there is an increase in real income of $500 billion in this economy. Given your consumption function, what is the change in consumption given this change in real income?
Consider an individual consumption function, which is the standard textbook consumption function, that is, has a y-intercept of autonomous consumption and is linear in the disposable income. Assume that the slope of this consumption function equals 0.7, and that the autonomous consumption equals $20 billion in the aggregate economy.
a. Write down the consumption function for this economy.
b. What is the marginal propensity to save (MPS) in this example?
c. Suppose there is an increase in real income of $500 billion in this economy. Given your consumption function, what is the change in consumption given this change in real income?
Expert's answer
A) Since MPS is measured as ratio of change in savings to change in income, its value lies between 0 and 1.
Also, marginal propensity to save is opposite of marginal propensity to consume.
B) Mathematically, in a closed economy, MPS + MPC = 1, since an increase in one unit of income will be either consumed or saved.
