Question

Which of the following relations is not correct? (LO1, 2) a) \(\mathrm{MPC}+\mathrm{MPS}=1\) d) \(1-\mathrm{APS}=\mathrm{APC}\) b) \(\mathrm{APC}+\mathrm{APS}=1\) e) \(1-\mathrm{MPC}=\mathrm{MPS}\) c) \(\mathrm{MPS}=\mathrm{MPC}+1\)

Short answer

The incorrect relation is Relation C: \(\mathrm{MPS}=\mathrm{MPC}+1\).

Step-by-step solution

1. Analyze Relation A

Relation A is \(\mathrm{MPC}+\mathrm{MPS}=1\). This relation states that the sum of the Marginal Propensity to Consume and the Marginal Propensity to Save should equal 1. This is because, at any given level of income, an individual can only either consume or save the income. Therefore, this relation is correct.

2. Analyze Relation B

Relation B is \(\mathrm{APC}+\mathrm{APS}=1\). Similar to Relation A, this relation states that the sum of the Average Propensity to Consume and the Average Propensity to Save should equal 1. This is because the average propensity values also represent the fractions of income being consumed or saved. Therefore, this relation is also correct.

3. Analyze Relation C

Relation C is \(\mathrm{MPS}=\mathrm{MPC}+1\). This relation states that the Marginal Propensity to Save equals the Marginal Propensity to Consume plus 1. This is not correct, as it implies that the individual is saving more than the total income and not consuming anything, which is not possible. Therefore, this relation is incorrect.

4. Analyze Relation D

Relation D is \(1-\mathrm{APS}=\mathrm{APC}\). This relation states that the Average Propensity to Consume equals 1 minus the Average Propensity to Save. Since APC and APS should always add up to 1, this relation is correct.

5. Analyze Relation E

Relation E is \(1-\mathrm{MPC}=\mathrm{MPS}\). This relation states that the Marginal Propensity to Save equals 1 minus the Marginal Propensity to Consume. This is correct, as MPC and MPS should always add up to 1, given that they represent the division of income between consumption and savings. From the analysis above, the relation that is not correct is Relation C (\(\mathrm{MPS}=\mathrm{MPC}+1\)).

Key concepts

Marginal Propensity to Consume (MPC)

Marginal Propensity to Consume (MPC) is a concept in economics that measures the proportion of any additional income that a consumer spends on goods and services, rather than saving it. Think of MPC as the percentage of extra income you earn that you'll spend rather than save. Understanding MPC is crucial for analyzing consumer behavior. For example, if someone receives an extra \(100 and they spend \)80 of it on a new pair of shoes, the MPC would be calculated as 0.8. This is obtained by dividing the additional consumption by the additional income: \[ \text{MPC} = \frac{\text{Change in Consumption}}{\text{Change in Income}} \]MPC is a key factor in determining the overall level of consumption in an economy and is crucial for governments and businesses when predicting economic growth. An essential aspect of MPC is that it can never be greater than 1. This is simply because all available income is either spent or saved. Consequently, economists also rely on the concept of the Marginal Propensity to Save (MPS) where the sum of MPC and MPS equals 1 in the simplest economic model.

Average Propensity to Save (APS)

The Average Propensity to Save (APS) is the fraction of total income that a household saves. It is an important indicator of savings behavior over time. APS is different from MPS because APS considers total income levels whereas MPS looks at changes in income levels.Think of APS as a long-term measure. Whereas we previously examined how additional income is split into consumption and savings using MPC and MPS, APS uses the entire income earned: \[ \text{APS} = \frac{\text{Savings}}{\text{Total Income}} \]For example, if you earn \(1,000 in a given month and save \)200, your APS is 0.2 or 20%. This statistic helps economists understand how much money people tend to save, which can impact financial planning and economic predictions. Additionally, APS often complements the Average Propensity to Consume (APC), and their sum equals 1. This reflects the simple truth that every dollar of income is either saved or spent, forming a complete understanding of how income is allocated.

Income Analysis

Income analysis involves examining how individuals and households allocate their income across various needs and wants. It explores the balance between consumption and savings and is pivotal for various economic projections and decisions.When using income analysis, we examine how both the Marginal and Average propensities interact. For example, in the context of the exercise described, key relationships like \(\text{MPC} + \text{MPS} = 1\) and \(\text{APC} + \text{APS} = 1\) form foundational insights. These relationships demonstrate how income is fully utilized—either being consumed or saved. For practical purposes, governments and businesses use this analysis to predict and influence economic outcomes. For example, during a recession, a high MPC could imply potential policies that aim to encourage consumption by increasing disposable income. Moreover, this analysis helps in identifying economic trends through individual spending and saving behaviors, thereby providing a basis for monetary policy and fiscal decisions. Understanding how income is divided allows economists to frame strategies to stimulate or stabilize economic growth effectively.