Question

In year 1, Adam earns \(1,000 and saves \)100. In year 2, Adam gets a \(500 raise so that he earns a total of \)1,500. Out of that \(1,500, he saves \)200. What is Adam’s MPC out of his $500 raise?

1. 0.50

2. 0.75

3. 0.80

4. 1.00

Short answer

Option (c): 0.80

Step-by-step solution

Meaning of marginal propensity to consume

The marginal propensity to consume denotes how much proportion people are willing to consume out of their income. It represents the slope of the consumption curve. The ratio of change in consumption to the change in income gives the value of MPC.

The mathematical expression for MPC is as follows:

$MPC=\frac{△Consumption}{△Income}$

Calculation for Adam’s MPC

When Adam was earning $1000 and saving $100, he was consuming $900 (=1000-100) worth of goods and services. Now, if Adam is earning $1500 and saving $200, he is consuming $1300 (=1500-200) worth of goods and services. The change in income is

$500 (=1500-1000) and change in consumption is $400 (1300-900).

Thus, the MPC is calculated as follows:

$$\begin{gathered} MPC=\frac{△Consumption}{△Income} \\ =\frac{400}{500} \\ =0.8 \end{gathered}$$

Therefore, Adam’s MPC out of his increment is 0.80.