Question

If the MPS rises, then the MPC will: LO30.1 a. Fall. b. Rise. c. Stay the same.

Short answer

a. Fall.

Step-by-step solution

Understanding MPS and MPC

MPS stands for Marginal Propensity to Save, and MPC stands for Marginal Propensity to Consume. They represent the proportion of any additional income that is saved and consumed, respectively. In equation form: \[ MPS + MPC = 1 \].

Analyze the Impact of a Rise in MPS

If the MPS rises, it means that a larger fraction of any additional income is being saved. Since the total of MPS and MPC must be 1, if MPS increases, the MPC must adjust to maintain the equation.

Determine the Change in MPC

Given that MPS + MPC = 1, and MPS increases, the only way to keep the equation balanced is for MPC to decrease by the same amount that MPS increases, meaning that MPC will fall.

Key concepts

Marginal Propensity to Save

The Marginal Propensity to Save (MPS) is a concept in economics that measures the proportion of an increase in income that a consumer saves rather than spends on goods and services. The MPS is a crucial component in understanding how individuals choose to allocate additional income they receive. When consumers receive extra income, they have to decide on what portion to save. This decision is not random; it usually reflects their confidence in the economy, future income expectations, and current financial goals. A higher MPS indicates that individuals choose to save a greater share of any additional income.

• MPS is calculated as the change in savings divided by the change in income.
• Expressed as a fraction, it gives insight into saving behavior.
• If MPS is 0.2, it means 20% of additional income is saved.

Understanding MPS helps policymakers predict how changes in fiscal policy will impact saving rates. An economy with a high MPS tends to have lower immediate consumption, which can affect overall economic growth.

Marginal Propensity to Consume

The Marginal Propensity to Consume (MPC) complements the understanding of how individuals allocate their income, specifically focusing on consumption. It measures the fraction of additional income that is spent on consumption rather than saved. The MPC is vital for economists and policymakers because it helps forecast how changes in income levels may translate into consumer spending. When individuals receive extra income, they decide how much of it to use for purchases of goods and services. A high MPC suggests that most of the additional income is being spent and can lead to increased demand for products in the economy.

• MPC is calculated as the change in consumption divided by the change in income.
• For example, if the MPC is 0.8, it implies 80% of additional income is spent.
• Usually, MPC and MPS add up to 1, reflecting how extra income is divided.

This concept is crucial for formulating economic policies, as it reflects consumer confidence and spending habits. Governments may adjust taxes and incentives based on average MPC to manage economic activity effectively.

Income Allocation in Economics

Income allocation is a fundamental concept in economics that describes how individuals and households distribute their income across saving and consumption. Balancing these two allocations is key to understanding economic behavior at both a micro and macroeconomic level. In essence, income received by individuals can be distributed in three primary ways:

• It can be consumed by purchasing goods and services.
• It can be saved for future use, which affects capital accumulation and economic growth.
• It can be taxed by governments, influencing public spending and investments.

Economists study the decision-making processes behind income allocation to understand and predict how economic policies will influence the economy. Factors like income level, interest rates, economic outlook, and cultural attitudes towards saving and spending play significant roles. By analyzing how income is allocated, policymakers and businesses can derive insights into consumer preferences and make informed decisions aimed at stimulating economic development and ensuring financial stability.