Explain the following statement by ILLUSTRATING each case: “Changes in disposable income lead to movements along...

Explain the following statement by ILLUSTRATING each case: “Changes in disposable income lead to
movements along the consumption function, whereas changes in wealth or other factors lead to a shift of
the consumption function.”

Expert Solution

The given statement is correct. The consumption function is based on the following equation:

C = f(Y) = a + bY

Where Y = disposable income and C = consumption expenditure, a= autonomous consumption expenditure and b = marginal propensity to consume.

Hence, any change in Y will cause the movement along this same consumption function. This is because changes in Y will give us just another point of the same schedule.

However, the consumption function assumes that only the disposable income varies and all other factors remain constant. Thus, when other factors such as wealth etc. will change, the result is the shift in the consumption fucntion itself. This shift can be forward or backward depending on the nature of the change that has taken place.

Rahul Sunny answered 1 year ago

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