Question

Suppose that the linear equation for consumption in a hypothetical economy is C = 40 + 0.8Y. Also, suppose that income (Y) is $400. Determine

1. the marginal propensity to consume,

2. the marginal propensity to save,

3. the level of consumption,

4. the average propensity to consume,

5. the level of saving, and

6. the average propensity to save.

Short answer

1. The MPC is 0.8.

2. The MPS is 0.2.

3. The level of consumption in the economy is $360.

4. The economy’s average propensity to consume is 0.9.

5. The economy saves only $40.

6. The average propensity to save in the economy is 0.1.

Step-by-step solution

Value of MPC

The consumption function states that consumption is a proportionate function of income, generally represented as C = a + bY, where b is the slope of the consumption curve or MPC.

Therefore, in the equation C = 40 + 0.8Y, 0.8 is the marginal propensity to consume.

Calculation for MPS

MPS = 1- MPC

MPS = 1 – 0.8

MPS = 0.2

Therefore, the economy’s marginal propensity to save is 0.2.

Calculation for consumption level

C = 40 + 0.8Y and Y = $400

On placing the value of Y into the consumption function, the following is obtained:

C = 40 + 0.8×400

C = 40 + 320

C = 360

The economy’s consumption is $360.

Finding economy’s APC

The average propensity to consume is calculated as follows:

APC = Consumption/Income

APC = 360/400

APC = 0.9

Thus, the average propensity to consume in the economy is 0.9.

Level of saving

The portion of income not consumed is saving.

Y = C + S, or

S = Y – C

Placing the values of Y and C

S = 400 – 360

S = 40

Therefore, the economy saves $40.

Economy’s average propensity to save

The average propensity to consume is the ratio of saving to income.

APC = Saving/Income

APC = 40/400

APC = 0.1

Thus, the average propensity to save in the economy is 0.1 or 10%.