Question

The marginal propensity to consume is:

	A.	expected to be between zero and one.
	B.	normally assumed to increase as taxes increase.
	C.	the amount by which consumption changes when wealth increases by one dollar.
	D.	equal to disposable income divided by consumption.

If the consumption function is given by C = 150 + 0.85( Y – T) and T increases by 1 unit, then national saving

	A.	increases by 0.15 units.
	B.	increases by 0.85 units.
	C.	decreases by 0.85 units.
	D.	decreases by 0.15 units.

Answer 1

Ans 1 - The marginal propensity to consume is expected to be between 0 and 1 . It is calculated by dividing change in consumption by change in income (disposable income)

Ans 2 - decreases by 0.15 units

savings is equal to the disposable income minus the level of consumption.

S=Y−T−C

Given that the consumption function is:

C=150+0.85(Y−T)

Then:

S= Y−T− [150 + 0.85 (Y−T)]

S= (Y-T)-150+0.15 (Y−T)

S= -150 + 0.15 (Y - T)

S=−150+0.15Y−0.15T

Therefore:

ΔS/ΔT=−0.15<0

This means that an increase in taxes (T) by one unit will reduce the level of savings by 0.15