Question

Assume that in a given year, consumption and saving schedules are as given (columns 1 through 3 in billions of dollars). $$ \begin{array}{|c|c|c|} \hline \begin{array}{c} \text { (1) } \\ \text { Level of output and } \\ \text { income } \\ (\mathrm{NNP}=\mathrm{D} 1) \end{array} & \begin{array}{c} (2) \\ \text { Consumption } \end{array} & \begin{array}{c} (3) \\ \text { Saving } \end{array} \\ \hline \$ 510 & 480 & 30 \\ \hline 530 & 495 & 35 \\ \hline \end{array} $$ a) Determine the average propensity to consume \((\mathrm{APC})\) and the average propensity to save (APS). b) Compute the marginal propensity to consume (MPC) and the marginal propensity to save (MPS).

Short answer

a) For Income level 1 (510), APC = \( \frac{480}{510} \approx 0.9412 \) and APS = \( \frac{30}{510} \approx 0.0588 \). For Income level 2 (530), APC = \( \frac{495}{530} \approx 0.9340 \) and APS = \( \frac{35}{530} \approx 0.0660 \). b) MPC = \( \frac{495 - 480}{530 - 510} \approx 0.75 \) and MPS = \( \frac{35 - 30}{530 - 510} \approx 0.25 \).

Step-by-step solution

Calculate APC (Average Propensity to Consume) for both Income levels

In order to calculate the APC, we will use the formula: APC = Consumption / Income. For Income level 1 (510): APC = \( \frac{480}{510} \) For Income level 2 (530): APC = \( \frac{495}{530} \)

Calculate APS (Average Propensity to Save) for both Income levels

In order to calculate the APS, we will use the formula: APS = Saving / Income. For Income level 1 (510): APS = \( \frac{30}{510} \) For Income level 2 (530): APS = \( \frac{35}{530} \)

Calculate MPC (Marginal Propensity to Consume)

In order to calculate the MPC, we will use the formula: MPC = Change in Consumption / Change in Income. Change in Consumption = Consumption level 2 - Consumption level 1 = \(495 - 480\) Change in Income = Income level 2 - Income level 1 = \(530 - 510\) MPC = \( \frac{Change \, in \, Consumption}{Change \, in \, Income} \)

Calculate MPS (Marginal Propensity to Save)

In order to calculate the MPS, we will use the formula: MPS = Change in Saving / Change in Income. Change in Saving = Saving level 2 - Saving level 1 = \(35 - 30\) Change in Income = Income level 2 - Income level 1 = \(530 - 510\) MPS = \( \frac{Change \, in \, Saving}{Change \, in \, Income} \)

Key concepts

Average Propensity to Consume

The Average Propensity to Consume (APC) helps us understand how much of the income is being spent on consumption. It is a key concept in macroeconomics that reveals consumer behavior by indicating the proportion of income allocated to consumption rather than saving. The APC is calculated using the formula:
\[ APC = \frac{Consumption}{Income} \]This means, for every dollar earned, APC shows how many cents are spent. For example, if APC is 0.94, it suggests that 94 cents of every dollar are spent on consumption. This information tells economists and policymakers how changes in income might influence consumer spending patterns.
A higher APC implies people are more willing to spend a large portion of their income. Conversely, a lower APC might suggest a tendency to save more. Understanding APC is crucial for predicting the impact of economic changes on consumer demand.

Average Propensity to Save

The Average Propensity to Save (APS) measures the fraction of income that is saved rather than spent. It complements the APC by demonstrating how savings behavior responds to changes in income. The APS is calculated as:
\[ APS = \frac{Saving}{Income} \]This ratio shows how much money from every dollar earned is set aside for future needs or investments. For instance, if APS is calculated as 0.06, it indicates that 6 cents of every dollar are saved.
APS is particularly useful in understanding trends in saving behavior across different income levels. A higher APS can signal a tendency toward increased financial security or preparation for the future, while a lower APS suggests more immediate consumption needs. This understanding can guide policies aimed at encouraging saving or spending based on economic conditions.

Marginal Propensity to Consume

The Marginal Propensity to Consume (MPC) is an important measure in macroeconomics, showing the change in consumption resulting from a change in income. It reflects how much more consumers will spend on goods and services if their income increases. The formula used is:
\[ MPC = \frac{\Delta Consumption}{\Delta Income} \]Where \(\Delta\) signifies a change, for example, an MPC of 0.75 implies that for every additional dollar earned, 75 cents are used for consumption.
This concept helps to understand the dynamics of spending in an economy. A high MPC means any income boost leads to greater consumption, stimulating economic growth. In contrast, a lower MPC might suggest that extra income goes predominantly into savings. Evaluating MPC helps policymakers assess how effective fiscal policies, like tax cuts, might be in boosting consumer spending and overall economic activity.

Marginal Propensity to Save

The Marginal Propensity to Save (MPS) refers to the portion of any additional income that an individual saves rather than spends on consumption. This concept is essential to assess savings behavior in response to income changes, calculated as:
\[ MPS = \frac{\Delta Saving}{\Delta Income} \]For example, if the MPS is 0.25, it indicates that for every extra dollar of income, 25 cents are saved.
Understanding MPS is crucial for policymakers as it complements the MPC. Together, they always sum up to 1, since additional income is either spent or saved. A higher MPS indicates a strong inclination toward saving, which could suggest more investment into future economic stability. Conversely, a lower MPS might hint at a focus on immediate consumption. Analyzing MPS helps in designing economic policies that need to stimulate saving or spending as part of broader economic strategies.