Question

3. Explain how the level of saving is determined in the simple Keynesian consumption function. What is the effect of an increase in disposable income on the level of saving?

Answer 1

Keynesian formula for consumption is

Consumption = autonomous consumption + marginal propensity to consume × disposable income.

We can write it as

$С = a + b*Yd$

In the same time disposable income consist of consumption and savings, so:

$Yd = C +S$

From that two formulas we're getting a formula for savings:

$S = Yd - C$

$S = -a + (1 - b)*Yd$

So −a is the level of autonomous saving and (1 − b) is the marginal propensity to save.

According to Keynesians, with the increase of disposable income - people consume a smaller fraction of their income: the average propensity to consume decreases$(APC = C/Yd)$ . And the average propensity to save increases$(APS = S/Yd)$ .