Question

John Maynard Keynes's proposition that a dollar increase in disposable income will increase consumption, but by less than the increase in disposable income, implies a marginal propensity to consume that is a. greater than or equal to one. b. equal to one. c. less than one, but greater than zero. d. negative.

Short answer

The correct relationship for the marginal propensity to consume (MPC) based on John Maynard Keynes's proposition is that it is less than one, but greater than zero. Therefore, the correct answer is: c. less than one, but greater than zero.

Step-by-step solution

Understand the propositions

Keynes suggests that consumption increases when disposable income increases, but the consumption increase is less than the increase in disposable income. Mathematically, this can be represented as follows: - Increase in Consumption = MPC × Increase in Disposable Income Since the consumption increase is less than the increase in disposable income, that means MPC × Increase in Disposable Income < Increase in Disposable Income.

Determine the Relationship to MPC

Now we need to find the relationship of the marginal propensity to consume and identify which of the choices (a, b, c, or d) represents this relationship correctly. - If MPC were greater than or equal to one, the consumption increase would be equal to or greater than the increase in disposable income. - If MPC were equal to one, the consumption increase would be equal to the increase in disposable income. - If MPC were less than one but greater than zero, the consumption increase would be less than the increase in disposable income. Comparing these relationships with the given propositions, we can identify the correct relationship.

Choose the Right Option

From the analysis we made above, we can determine that the marginal propensity to consume is less than one, but greater than zero. So the correct answer is: c. less than one, but greater than zero.

Key concepts

Keynesian Economics

Keynesian economics, named after the economist John Maynard Keynes, is a theory that centers on the idea that the total spending in an economy, known as aggregate demand, is the primary driving force for economic activity and growth. According to Keynesian theory, when businesses and households reduce their spending during times of economic downturn, the government should intervene by increasing its spending or cutting taxes.

Keynesians believe that this intervention can help to offset declines in private spending and thus 'kickstart' the economy. This concept is directly tied to the idea of fiscal policy, which involves the government manipulating its own budget to influence the overall economy. Keynesians argue that in the short term, demand is influenced more by confidence and expectations than by physical supply constraints.

In the context of disposable income and consumption, Keynes introduced the notion of the marginal propensity to consume (MPC), which plays a significant role in understanding how changes in income levels affect spending and, consequently, the economy as a whole.

Disposable Income

Disposable income is the amount of money that households have available for spending and saving after income taxes have been accounted for. It's essentially the net income that can be used at the discretion of the household. This concept is crucial because it represents the financial resources that individuals have to support consumption and saving behaviors.

Disposable income is intimately connected to economic health. When people have more disposable income, they tend to spend more, investing in goods and services. This increased spending can stimulate economic growth. Conversely, when disposable income decreases, households might cut back on spending, potentially leading to an economic slowdown.

The relationship between disposable income and consumption is illustrated by the consumption function, explicitly showing how income levels can affect spending habits within an economy. Understanding disposable income is essential for analyzing and predicting consumer behavior and economic trends.

Consumption Function

The consumption function is a fundamental concept in Keynesian economics that describes the relationship between total consumption and gross national disposable income. It illustrates how households make spending decisions based on their levels of income. The function typically takes the form of a simple equation:
\[ C = a + b(Yd) \]
where \( C \) is total consumption, \( a \) is autonomous consumption (the consumption level when income is zero), \( b \) is the marginal propensity to consume (MPC), and \( Yd \) represents disposable income.

The MPC is particularly important here; it indicates how much consumption will change with a change in disposable income. For example, if the MPC is 0.75, this means that for every additional dollar of disposable income, consumption will increase by 75 cents. The remainder of the income may go into savings or debt repayment.

The consumption function allows economists and policymakers to predict how changes in income levels, taxation, and government spending might influence spending behavior in the economy, which in turn affects overall economic activity.