Question

The consumption function tells us that, as income rises, consumption \((\mathrm{LO3})\) a) declines b) remains the same c) rises more slowly than income d) rises more quickly than income

Short answer

c) As income rises, consumption rises more slowly than income.

Step-by-step solution

Understanding the Consumption Function

The consumption function is an economic concept that shows the relationship between an individual's or a nation's income level and their spending habits. In general, as income increases, consumption also increases. However, the rate at which consumption increases can differ based on the particular consumption function. In this question, we need to determine how consumption behaves as income rises.

Comparing the given options

We have four options to consider: a) Declines: This option suggests that as income rises, consumption decreases. This is counterintuitive, as one would generally expect consumption to increase with higher income. b) Remains the same: This option suggests that there is no change in consumption as income rises. This is also counterintuitive, as increased income should lead to increased consumption. c) Rises more slowly than income: This option suggests that consumption increases as income rises, but at a slower rate than the increase in income. d) Rises more quickly than income: This option suggests that consumption increases at a faster rate than the increase in income.

Applying the principles of the consumption function

We know that consumption will generally increase as income rises, so we can eliminate options a) and b). In most cases, consumption will not increase at a faster rate than income, as individuals tend to save more when their income rises. Therefore, option d) is also unlikely.

Conclusion

Based on the principles of the consumption function and after analyzing the given options, we can conclude that the correct answer is: c) As income rises, consumption rises more slowly than income.

Key concepts

Income

Income is the amount of money earned by an individual or entity over a specific time period, such as a week, month, or year. It can come from various sources, including wages, investments, or business activities.

Understanding how income influences economic behavior is key in studying personal and national economics:

• Income levels directly impact purchasing power. More income generally means more possibilities to buy goods and services.
• Higher income can lead to both increased consumption and increased saving, depending on individual preferences.
• Stable income provides a sense of security that encourages spending and investment.

When studying income in the context of the consumption function, it's important to remember that not all additional income will be spent. People often allocate extra income towards savings or investments.

Spending Habits

Spending habits refer to the manner in which individuals allocate their income to purchase goods and services. These habits can vary significantly based on personal preferences, cultural influences, and economic conditions.

There are several key factors that influence spending habits:

• Income: As income increases, people often have more discretionary income available for non-essential purchases.
• Needs vs. Wants: Individuals prioritize spending based on urgent needs like food and housing before moving to wants such as entertainment and leisure.
• Cultural and Social Influences: Culture and peer pressure can greatly impact spending patterns. For example, some cultures prioritize savings over consumption.
• Future Expectations: If people are optimistic about future income, they may spend more freely now.

Understanding spending habits helps economists predict changes in economic activities based on shifts in income or market trends.

Economic Concepts

Economic concepts are fundamental ideas and principles that help explain how economies function. These concepts provide a framework for analyzing economic activity and making informed decisions.

Here are some essential economic concepts linked to the consumption function:

• Marginal Propensity to Consume (MPC): This measures how much consumption changes with a change in income. It's pivotal in the consumption function, as it helps determine how increases in income affect overall economic growth.
• Consumption Function: This describes how varying levels of income affect consumption, indicating that while consumption increases with income, it does so at a decreasing rate.
• Savings Function: Complementing the consumption function, it shows how savings increase as income rises, providing a buffer for future uncertainties.

Grasping these concepts is crucial for understanding broader economic behaviors and policy implications.