Question

The sum of the marginal propensity to consume \((M P C)\) and the marginal propensity to save \((M P S)\) always equals a. 1 b. 0 c. the interest rate. d. the marginal propensity to invest \((M P I)\)

Short answer

The sum of the marginal propensity to consume (MPC) and the marginal propensity to save (MPS) always equals 1. This is because an increase in income will either be spent on consumption (MPC) or saved (MPS), so the total proportion of income that was increased must be allocated to either consumption or saving. Therefore, the correct answer is a. 1.

Step-by-step solution

1. Understand the concepts of MPC and MPS

Marginal propensity to consume (MPC) is the additional consumption resulting from one additional unit of income. Similarly, marginal propensity to save (MPS) represents the additional saving resulting from one additional unit of income. These two concepts are closely related, as an increase in income can either be spent on consumption or saved.

2. Analyze the relationship between MPC and MPS

Since an increase in income will either be spent on consumption (MPC) or saved (MPS), we can say that the sum of the proportions allocated to consumption and saving will always equal the total proportion of income that was increased. In other words, \[ MPC + MPS = 1 \]

3. Evaluate the answer choices

Using the relationship between MPC and MPS we established above, we can now evaluate the answer choices: a. 1: This answer choice is correct, as we showed that the sum of MPC and MPS always equals 1. b. 0: This answer choice is incorrect, as the sum of MPC and MPS equals 1, not 0. c. the interest rate: This answer choice is also incorrect, as interest rates are not directly related to the sum of MPC and MPS. d. the marginal propensity to invest (MPI): This answer choice is irrelevant to the question since MPI is not a part of the relationship between MPC and MPS. Based on this analysis, the correct answer is: a. 1

Key concepts

Marginal Propensity to Consume

One of the key concepts in understanding consumer behavior in economics is the Marginal Propensity to Consume (MPC). It refers to the ratio of change in consumption that comes from a change in disposable income. In other words, if consumers receive an additional dollar in income, the MPC determines how much of that dollar is spent on consumption rather than saved. This principle has profound implications for economic policies, particularly those related to stimulating economic growth. For instance, a high MPC means that income increases lead to significant increases in consumption, which can potentially boost overall economic activity.

The formula to calculate MPC is given by the ratio:
\[ MPC = \frac{\Delta C}{\Delta Y} \]
Where \( \Delta C \) represents the change in consumption, and \( \Delta Y \) is the change in disposable income. Understanding MPC is crucial for predicting consumer spending and designing effective fiscal policies.

Marginal Propensity to Save

Closely associated with the concept of the marginal propensity to consume is its counterpart, the Marginal Propensity to Save (MPS). It measures the fraction of additional income that a household saves rather than spends on consumption. The MPS is critically important for comprehending how savings behavior impacts the economy. A higher MPS indicates that with an increase in income, households prefer to save more, possibly reflecting a cautious outlook towards the future.

Mathematically, MPS is calculated as follows:
\[ MPS = \frac{\Delta S}{\Delta Y} \]
Here, \( \Delta S \) is the change in savings and \( \Delta Y \) stands for the change in disposable income. This concept is pivotal in macroeconomic models because savings eventually translate into investment, driving long-term economic growth.

Income Consumption Relationship

The Income Consumption Relationship is a fundamental concept illustrating how consumption varies with changes in income. This relationship is typically depicted by the consumption function, a core component of Keynesian economics. It clearly demonstrates that as disposable income increases, consumption also increases, albeit by a smaller proportion due to the marginal propensity to consume being less than one. Economists use this relationship to predict consumer expenditure patterns and understand the underlying tendencies in various income groups.

The relationship can be reinforced by the formula:
\[ C = a + bY \]
where \( C \) is the total consumption, \( a \) represents autonomous consumption (consumption that does not depend on income), \( b \) is the MPC, and \( Y \) indicates disposable income. This relationship is vital to comprehend because it can dictate the direction and magnitude of multiplier effects in the economy.

Basic Macroeconomic Principles

At the heart of economic analysis are the Basic Macroeconomic Principles, which provide a framework to understand the complex interplay of factors that shape the economy. The principles encompass concepts like supply and demand, inflation, unemployment, fiscal policy, and, of course, the mechanisms of consumption and saving discussed previously through MPC and MPS. Macroeconomics emphasizes the behavior of the aggregate economy—how the actions of all the individuals and firms come together to influence growth, price levels, and employment rates. It's a dance of various elements where policies, market responses, the business cycle, and external shocks all contribute to the performance of the economy.

Understanding these principles is essential for a comprehensive view of how decisions by consumers, businesses, and governments affect macroeconomic outcomes, setting the stage for informed policy-making aimed at maintaining economic stability and promoting sustainable growth.