Wealth and Consumption Function

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Questions and Answers

What is the relationship between income and consumption?

As income rises, so does consumption.

What is the average propensity to consume (APC) and how is it calculated?

The APC is the ratio of consumption expenditure to income, calculated as APC = C/Y.

How does Keynes distinguish between the MPC and the APC?

Keynes distinguishes between the MPC and the APC, with MPC being the change in consumption in response to a change in income, and APC being the ratio of consumption expenditure to income.

If the MPC is 0.75, what does it mean?

It means that for every additional unit of income, consumption increases by 0.75 units. Signup and view all the answers

What is the consumption function, and how is it related to income and savings?

The consumption function shows how consumption (C) varies with income (Y), and is related to savings (S) through the equation Y = C + S. Signup and view all the answers

How is savings (S) related to income (Y) and consumption (C)?

Savings (S) is income not consumed, therefore S = Y - C. Signup and view all the answers

What happens to household savings as income increases?

As income increases, the capacity to save also increases. Signup and view all the answers

What is autonomous consumption, and how is it related to income?

Autonomous consumption is not related to income, and remains constant even when income changes. Signup and view all the answers

What does the consumption function represent?

The consumption function represents the various amounts of money households plan to spend on consumption goods at various levels of income, assuming all other factors such as prices and consumer expectations remain constant. Signup and view all the answers

What is the algebraic representation of the consumption function?

C = a + bY Signup and view all the answers

What is autonomous consumption?

Autonomous consumption is the level of consumption that would be made by households irrespective of the level of income. Signup and view all the answers

What is the marginal propensity to consume (MPC)?

The marginal propensity to consume (MPC) is the increase in consumption expenditure as a result of a one-unit increase in disposable income. Signup and view all the answers

What is the relationship between consumption and disposable income?

There is a positive relationship between consumption and disposable income, as an increase in income leads to an increase in consumption. Signup and view all the answers

What is the difference between the average propensity to consume and the marginal propensity to consume?

The average propensity to consume is the proportion of total income spent on consumption, while the marginal propensity to consume is the proportion of additional income spent on consumption. Signup and view all the answers

How does an increase in wealth affect the consumption and savings functions?

An increase in wealth would likely shift the consumption and savings functions upward, as consumers are likely to spend more and save more. Signup and view all the answers

What happens to consumption when consumers are optimistic about the future?

Consumption increases, as consumers are more willing to spend money when they are optimistic about the future. Signup and view all the answers

How does a reduction in taxes affect consumption and savings?

A reduction in taxes increases disposable income, leading to an upward shift in both the consumption and savings functions. Signup and view all the answers

What happens to consumption when there is a decrease in the value of stock holdings?

Consumption decreases, as a decrease in wealth would lead to a decrease in consumption. Signup and view all the answers

How does consumer pessimism about the future affect consumption?

Consumption decreases, as consumers are less likely to spend money when they are pessimistic about the future. Signup and view all the answers

What is the effect of an increase in disposable income on consumption and savings?

An increase in disposable income leads to an increase in consumption and savings, as consumers have more income to spend and save. Signup and view all the answers

Study Notes

Wealth and Consumption

An increase in the value of stocks, for example, would make asset holders wealthier, leading to increased consumption even at the same income level.
This results in an upward shift in both the consumption function and the savings function.
Conversely, a decrease in wealth would have the opposite effect.

Expectations and Consumption

Consumers are more likely to spend money when they are optimistic about the future, such as expecting a future income increase.
An increase in consumer optimism tends to shift the consumption function upward.
Conversely, if consumers are pessimistic about the future of the economy, they might decrease their consumption, even if actual current income has not changed.

Taxes and Consumption

A reduction in taxes increases disposable income, shifting the consumption and savings function upwards.
At different levels of income, disposable income increases, and consumption and savings also increase.

The Average Propensity to Consume (APC)

APC is the ratio of consumption expenditure to income, represented by APC = C/Y.
APC shows the fraction of income that households spend on consumption on average.

Marginal Propensity to Consume (MPC) and Average Propensity to Consume (APC)

MPC is the ratio of the change in consumption expenditure to the change in income, represented by MPC = ΔC/ΔY.
If income increases and consumption expenditure also increases, the MPC can be calculated.

The Consumption and Savings Function

Households can use their income in two ways: spend all on consumption (C) or spend some and save (S) the rest.
The household savings function is also a function of household income, and the higher the income, the greater the capacity to save.
Savings (S) is income not consumed, represented by S = Y – C.

The Consumption Function

The consumption function shows the various amounts of money households plan to spend on consumption goods at various levels of income, all other things being constant.
The consumption function is the equation that expresses a positive relationship between consumption (C) and disposable income (Y), represented by C = F(Y) or C = a + bY.
In this equation, a is autonomous consumption, and b is the marginal propensity to consume (MPC).

Autonomous Consumption

Autonomous consumption is the level of consumption that would be made by households irrespective of the level of income.
It is the minimum level of consumption that must be undertaken by the household even at a zero level of income.

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Description

Learn how changes in wealth, such as stock value increases, affect consumption and savings behavior. Understand the impact on the consumption function and savings function.