Question

1. Which is the main determinant of the consumption level? Describe the relationship.

2. What is Keynes’ ‘Fundamental psychological law’?

3. What is the marginal propensity to consume (MPC) and its formula? What is the marginal propensity to save (MPS) and its formula?

4. What is the slope of the consumption function?

Answer 1

Answer 1 :-

The following are the five most important variables that determine the level of consumption ;

•Current disposable income(most important determinant)

• Household wealth

• Expected future income

• The price level

• The interest rate

Consumption function is the relationship between consumption spending and disposable income(Yd)

C = a + b Yd, where a is the autonomous consumption, b is the marginal propensity to consume and Yd is the disposable income.

Answer 2 :-

The Keynesian psychological law states that people have the propensity to spend a large fraction, but not all, of additional income.

Keynes's fundamental psychological law of consumption stated that, as income grows, people will consume more, but not by as much as their income increases.

Answer 3 :-

Marginal Propensity to Consume is the change in how much disposable income spent.

It is denoted by MPC and always less than 1 but more than zero.

MPC = Change in Consumption/Change in disposable income= C/Yd

Marginal propensity to save :

Marginal Propensity to Save is the change in how much disposable income saved.

It is always less than one but more than zero and is denoted by MPS

MPS = Change in saving/Change in disposable income = S/Yd

Relationship between MPC and MPS is,

MPC+MPS = 1

Answer 4 :-

The slope of the consumption function equals the marginal propensity to consume

For the straight-line consumption function, the slope is the same at all levels of income and is given by the change in consumption divided by the change in disposable income that causes it.