Can MPS or MPC ever be negative ?

Answer :

No, neither MPS or MPC can ever be negative. Because MPS is the ratio between additional saving (∆S) and additional income (∆Y). Likewise, MPC is the ratio between additional consumption (∆C) and additional income (∆Y). The ratio ∆S / ∆Y refers to slope of Saving function which is always positive because of positive relationship between S and Y. Likewise, the ratio ∆C / ∆Y refers to slope of consumption function which is always positive because of positive relationship between C and Y.

Also read :

Consumption Function

Saving Function

Explain that sum total of MPC and MPS equal to 1

Answer :

We know that:

MPS = ∆S / ∆Y

MPC = ∆C / ∆Y

We also know that:

(Additional income is either used in increasing consumption or saving)

∆Y = ∆C +∆ S

(Dividing both sides of the equation by ∆Y)

∆Y / ∆Y = ∆C / ∆Y + ∆S / ∆Y

1 = MPC + MPS

So that,

MPC + MPS = 1

Or, MPC = 1 – MPS

Or, MPS = 1 – MPC

MPC is generally less than unity and greater than zero. It means that a part of increase in income is consumed and the other part is saved.

So, the aggregate MPC and MPS must be equal to unity. Thus, if half of the increase in income is spent on consumption, the other half must be saved.

So that when MPC = 1/ 2 (half), then MPS = 1/ 2(half) also implying that

MPC + MPS = 1 always.

Explain that sum total of APC and APS is equal to 1

Answer :

We know that: APC = C / Y  and APS = S / Y

We also know that:

Y = C + S (income is either consumed or saved)

(Dividing both sides of the equation by Y)

Y / Y = C / Y + S / Y

1 = APC + APS

So that,

APC + APS = 1

Or, APC = 1 – APS

Or, APS = 1 – APC

Give the equation for a linear consumption function?

Answer :

The general equation for a linear consumption function is expressed as :

C = a + cY
Where,

C : is the aggregate consumption expenditure

a : represent a positive constant equal to the level of consumption at zero level of income or autonomous consumption.

c : denotes marginal propensity to consume or the slope of the consumption line

Y : Income

Explain consumption function in tabular and graphical form?

To know about this read Tabular Explanation of Consumption function
Graphical Explaination of Consumption function

In APC and MPC the value of which parameter can be greater than one and when ?

Answer :

Value of APC can be greater than one. It happens when the level of income is low and C >Y.

Value of MPC cannot be greater than one. MPC is the ratio between additional consumption and additional income (∆C / ∆Y). Since additional consumption is only part of additional income, and after certain level of income is reached, people start saving a part of income. Since increase in consumption (∆C) is less than that of increase in income (∆Y) the value of MPC must be less than one or cannot be greater than one.

Explain why MPC is always positive and not greater than one ?

Answer :

According to Keynesian Consumption function, there is always some minimum level of C (consumption) irrespective of level of Y (income), since at zero level of income also people will consume (past savings), so consumption is positive. Thus MPC is always positive, cannot be less than zero.

Also an increase in Consumption tends to lag behind the increase in income, because, after certain level of income is reached, people start saving a part of income. Since increase in consumption (∆C) is less than that of increase in income (∆Y) the value of MPC must be less than one.

Thus,

MPC (c) ranges from zero and 1

0 < c < 1

Define Average and Marginal Propensity to consume. Explain with a numerical example.

Answer :

The average propensity to consume (APC) refers to the proportion of income devoted to consumption. It defines the relationship between total consumption and total income. APC = C/Y Marginal propensity to consume refers to the ratio of change in consumption to change in income.

MPC = ∆C / ∆Y

For example :

If income (Y), is Rs. 100 crore and consumption (C) is Rs. 80crore, 

the APC = C / Y
APC = 80 / 100 = 0.8 or 80 %

This indicates that 80 per cent of the income is spent by way of consumption expenditure in the economy.

If income (Y), increases to Rs. 1200 crore and consumption expenditure increases to Rs. 900 crore,

then,

MPC = ∆C / ∆Y

MPC = 900 - 800 / 1200 – 1000

= 100 / 200

= 0.5

it means that change in income by Rs. 200 crore has caused a change in consumption by Rs. 100 crore.

What is Fundamental Psychological Law ?

Answer :

This law is propounded by Keynes. It states that as income of the people increases, their consumption also rises. But the entire increase in income is not converted into consumption. A part of it is often saved. Also the rate at which consumption increases is often less than the rate at which income increases.

What is consumption Function ?

Answer :

Consumption function shows the functional relationship between the desired consumption expenditure and income. The relationship can algebraically expressed as C=f(y), where C stands for consumption expenditure, f is the function and Y is the income. There is a direct relationship between income and desired or planned consumption expenditure, the level of consumption increases with increase in income.

To know more about this topic also read - Consumption Function

What is consumption expenditure ?

Answer :

The amount of money spent by consumer on the purchase of goods and services in order to satisfy their wants directly is called consumption expenditure. Consumption expenditure mainly depends on income, and are directly related, it increases as income increases.

What is Aggregate Demand and its components ?

To know read -  Aggregate Demand and its Components

What is macroeconomics? State its vital components

Answer :

Macroeconomics refers to the study of economic problem or economic issues at the level of an economy as a whole. In this the focus shifts from maximization of individuals gain (as in microeconomics) to maximization of social welfare. The central issues in this relate to the overall level of employment, growth rate of national output, the general price level, and stability of the economy.

The vital components of Macroeconomics are:

1. Theory related to Equilibrium level of output and Employment : It studies how equilibrium is struck when Aggregate supply (AS) = Aggregate Demand (AD).

2. Theory related to Inflationary and Deflationary Gap in the economy : It studies how departure from full employment equilibrium output causes inflationary or deflationary gap.

3. Theory of Multiplier : It analysis the process of income generation by investment expenditure in the economy.

4. Money supply and Credit Creations : It studies the components of money supply and role commercial banks in money supply through credit creation.

5. Fiscal and Monetary Policies : Budgetary and monetary measures to correct the situations of inflationary and deflationary gap.

6. Government Budget : It focuses on the measurement and impact of budgetary deficits in the economy.

7. Exchange rate and BOP : It analyses how exchange rate is determined in the international money market and how BOP impacts the level of economic activity in the domestic economy.

What is the Difference between Microeconomics and Macroeconomics

to know about this read - Difference between Microeconomics and Macroeconomics

What is the problem of Resource Allocation

Answer :

The problem of resource allocation refers to the problem of rational management of resources, or is the problem of allocating resources to different uses in a manner such that scarce resources are optimally utilized.

The problem arises because resources are scarce and have alternative uses.

How is “choice” a core parameter in the study of economics ?

Answer :

Due to the scarcity of resources and resources has alternative uses; we are facing the Problem of choice. It is the problem of allocating scarce resources to alternative uses.

For example: Land (a scarce means of production) can be put to alternative uses, you can build factories on it or construct houses or grow crops on it or covert it into a playground.

Problem of choice or the problem of allocation of resources to alternative uses is the basic economic problem. This is the root cause of emergence of economics as a subject matter of study.

Economics is concerned with the study and solution of economic problems in a manner such that the individuals (at micro levels) are able to maximize their gains, and the society (at macro levels) as a whole is able to maximize its social welfare.

Why does an economic problem arise?

Answer :

Human wants are unlimited, no matter how rich we are, the available resources are never enough to fulfill our needs.

Also the resources available (land, labor, capital and entrepreneur) are scarce and also have alternative uses.

These two conditions lead to the problem of choice or the problem of allocation of resources to alternative uses. This is the basic economic problem.

Central Problem of an economy

Introduction :

No matter how rich we are, the available resources are never enough to satisfy our never ending needs so it is rightly said “Needs always outpace our means”.

Also scarcity of resources is a hard reality Resources are not only scarce, but have alternative uses as well.

For example: Land (a scarce means of production) can be put to alternative uses, you can build factories on it or construct houses or grow crops on it or covert it into a playground.

Due to the scarcity of resources and resources has alternative uses, we are facing the Problem of choice. It is the problem of allocating scarce resources(land) to alternative uses (factories, houses, crops or playground).

Monetary Policy – Qualitative Instruments to control money supply

Selective or Qualitative methods of credit control aim at regulating and controlling the allocation of credit among various users rather than influencing the general availability of credit.

These are broadly explained below:

1) Margin Requirement:

The commercial banks generally give loans to their customers against some securities. They do not give loans equal to the full amount of the value of security, but of an amount which is less than its value.

The margin requirement of loans refers to the difference between the current value of the security offered for loans and the value of loans granted.

How does the Central Bank control Flow of Credit - Monetary Policy

Management of money supply is an important function of Central bank. High fluctuations in the volume of money (money supply) create the problems of inflation (excess demand) and deflation (deficient demand)

The central bank uses the Monetary Policy / Credit Policy for monetary management.

Monetary Policy is the policy of the central bank to regulate the availability, cost and use of money for achieving certain given objectives of the economic policy.