Question

What is the level of saving if: a. Disposable income is \(\$ 500\) and consumption is \(\$ 450\) ? b. Disposable income is \(\$ 1,200\) and the \(A P S\) is 9 ? c. The \(M P C\) cquals .9, disposable income rises from \(\$ 800\) to \(\$ 900\), and saving is originally \(\$ 120\) when income equals \(\$ 800\) ?

Short answer

a) Disposable income is $500 and consumption is $450. b) Disposable income is $1,200 and the Average Propensity to Save (APS) is 9%. c) Marginal Propensity to Consume (MPC) is 0.9, disposable income rises from $800 to $900, and saving is $120 when income equals $800. Answer: a) Saving = $50 b) Saving = $108 c) Saving = $30

Step-by-step solution

Scenario a

We are given disposable income as \(\$ 500\) and consumption as \(\$ 450\). So, to find the level of saving, we simply subtract consumption from disposable income: Saving = Disposable income - Consumption Saving = $500 - 450 Saving = $50

Scenario b

We are given disposable income as \(\$ 1,200\) and the APS as 9%. To find the level of saving, we multiply the disposable income by the APS: Saving = APS * Disposable income Saving = 0.09 * 1200 Saving = $108

Scenario c

We are given the MPC as 0.9, the disposable income rises from \(\$ 800\) to \(\$ 900\), and saving is originally \(\$ 120\) when income equals \(\$ 800\). First, we will find the change in income: Change in income = Final income - Initial income Change in income = $900 - 800 Change in income = $100 Next, we will find the change in consumption by multiplying the change in income by the MPC: Change in consumption = MPC * Change in income Change in consumption = 0.9 * 100 Change in consumption = $90 Finally, we will find the new saving level by adding the change in consumption to the initial saving level (as saving and consumption are inversely related): New saving level = Initial saving level - Change in consumption New saving level = $120 - 90 New saving level = $30

Key concepts

Disposable Income

Disposable income is a crucial concept in understanding personal finances. It represents the amount of money that a person or household has available to spend or save after all taxes have been paid. Think of it as the money in your pocket after taxes.
For example, if your monthly income is $3,000 and you pay $500 in taxes, your disposable income would be $2,500. This is the amount you can allocate towards expenses, investments, or savings.
Understanding disposable income helps individuals make informed spending and saving decisions. It aids in budgeting, as it directly impacts how much one can afford to consume or invest.

Consumption Function

The consumption function is a concept used to describe the relationship between disposable income and the total consumption expenditure. It helps predict how individuals might adjust their spending when their income changes.
At its core, the consumption function illustrates that as disposable income increases, the total consumption also tends to increase, but not necessarily at the same rate.
This relationship can be represented mathematically as: \[ C = a + bY_d \] where:

• \( C \) represents consumption,
• \( a \) is autonomous consumption (consumption when income is zero),
• \( b \) is the marginal propensity to consume, and
• \( Y_d \) is disposable income.

Understanding the consumption function allows economists to analyze consumer behavior and predict the impact of economic policies on consumption patterns.

Average Propensity to Save (APS)

The Average Propensity to Save (APS) is a metric illustrating the proportion of disposable income that a household saves rather than spends on consumption. It is expressed as a ratio or percentage.
The formula for APS is: \[ APS = \frac{S}{Y_d} \] where:

• \( S \) is the total savings, and
• \( Y_d \) represents disposable income.

For example, if a household's disposable income is \(1,200 and they save \)108, the APS would be 0.09 or 9%. This indicates that for every dollar of income, 9 cents are saved.
Understanding APS helps in assessing the saving behavior of consumers and can inform policy decisions aimed at encouraging savings.

Marginal Propensity to Consume (MPC)

The Marginal Propensity to Consume (MPC) quantifies the change in consumption that results from a change in disposable income. It is a key concept in economics, especially when analyzing how economic stimuli (like tax cuts) might alter consumer spending.
Mathematically, it is defined as: \[ MPC = \frac{\Delta C}{\Delta Y_d} \] where:

• \( \Delta C \) is the change in consumption, and
• \( \Delta Y_d \) represents the change in disposable income.

If the MPC is 0.9, it means that for every additional dollar of disposable income, consumer spending increases by 90 cents.
MPC is crucial for predicting how changes in income will affect overall economic consumption, guiding fiscal policies and economic forecasts.