Question

As a nation's income falls, induced consumption (LO5) a) rises b) falls c) remains the same

Short answer

As a nation's income falls, induced consumption also falls due to less disposable income for consumers. Therefore, the correct answer is (b) induced consumption falls.

Step-by-step solution

Understand the concepts

Induced consumption refers to the portion of consumption that varies directly with disposable income. As disposable income increases or decreases, so does induced consumption.

Consider the relation between a nation's income and induced consumption

As a nation's income falls, there is less disposable income for consumers to spend. With less disposable income, consumers would spend less on consumption. Therefore, induced consumption would be affected.

Choose the correct answer

Based on our understanding of the relationship between income and induced consumption, we can conclude the following: a) If a nation's income falls, induced consumption cannot rise. b) If a nation's income falls, induced consumption also falls as people have less disposable income. This is the correct answer. c) Induced consumption cannot remain the same if the nation's income falls, as the decrease in income results in less disposable income for consumers. So, the correct answer is (b) induced consumption falls as a nation's income falls.

Key concepts

Disposable Income

Disposable income is the amount of money individuals or households have available to spend or save after paying taxes. It serves as a critical indicator of economic health, reflecting the actual financial resources within the economy.
When people have more disposable income, they tend to spend more, enjoying a higher standard of living. Conversely, a reduction in disposable income leads to less spending and potentially a decline in the quality of life.
Understanding disposable income is essential because it directly impacts consumer behavior and spending power.

• The more disposable income individuals have, the more they are likely to consume goods and services.
• As disposable income decreases, consumption typically goes down, affecting businesses and the economy.
• It's affected by factors such as taxation policies, wage levels, and national economic health.

Consumption Function

The consumption function is an economic formula that describes the relationship between total consumption and gross national income. Proposed by John Maynard Keynes, this function explains how households are expected to spend their income.
The consumption function can be expressed as: \[ C = a + bY_d \]where:

• \(C\) is the total consumption.
• \(a\) represents autonomous consumption (consumption when income is zero).
• \(b\) is the marginal propensity to consume (MPC), showing the rate at which consumption changes with changes in disposable income \(Y_d\).

The function implies that consumption is partly dependent on disposable income.
Consumption increases as disposable income increases.
Consider the following:

• An increase in income results in an increase in consumption but by a smaller proportion due to savings.
• The MPC tells us how much more people will spend with each additional dollar of income.
• Autonomous consumption \(a\) ensures that even with zero income, some level of consumption occurs through savings or borrowing.

National Income

National income represents the total income earned by a country's citizens and businesses, encompassing wages, profits, rents, and any other earnings.
It's a crucial economic indicator that helps assess an economy's health, providing insight into the living standards and economic prosperity of a nation.
Components of national income include:

• Wages and salaries paid to labor.
• Profits for businesses.
• Rent received by property owners.
• Interest earned by lending money.

National income is essential in determining public policy and planning development. It drives decisions on investments, taxation, and government spending.
Higher national income often correlates with better education and healthcare systems, more extensive infrastructure, and a higher quality of life.
In times of economic downturn, a fall in national income signals decreased disposable income and consumption, as evidenced by the relationship between national income and induced consumption.