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. 80 crore, then

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