TutorOn by Sanath Withanage

Question:

Suppose that in a certain economy when the aggregate income increases from Rs. 500 million to Rs. 1 000 million, aggregate consumption expenditure increases from Rs. 800 million to Rs. 1 200 million. The values of autonomous consumption and the marginal propensity to consume in this economy are
(1) Autonomous Consumption: 500; MPC: 1.5
(2) Autonomous Consumption: 400; MPC: 0.8
(3) Autonomous Consumption: 300; MPC: 0.2
(4) Autonomous Consumption: 200; MPC: 0.1
(5) Autonomous Consumption: 100; MPC: 0.8

Correct Answer:

(2)

Answer Explanation:

First, calculate Marginal Propensity to Consume (MPC): Change in Consumption / Change in Income = (1200 – 800) / (1000 – 500) = 400 / 500 = 0.8. Next, use the consumption function C = a + bY (where a is autonomous consumption and b is MPC). Using the first data point: 800 = a + 0.8(500) $rightarrow$ 800 = a + 400 $rightarrow$ a = 400.

Topic: Consumption Theory Year: 2022