12.02.2018 Views

merged

Create successful ePaper yourself

Turn your PDF publications into a flip-book with our unique Google optimized e-Paper software.

Example 2B: The graph below illustrates the relationship between disposable income and<br />

consumption.<br />

Consumption<br />

(000s)<br />

$35 -<br />

30 -<br />

25 -<br />

20 -<br />

15 -<br />

10 -<br />

5-<br />

Marginal Propensity to Consume<br />

0 <br />

0 5 10 15 20 25 30 35<br />

Disposable Income (000s)<br />

The curve showing the relationship between disposable income and consumption (labeled C) is<br />

called the consumption function.<br />

The slope of the consumption function is the marginal propensity to consume (MPC). Marginal<br />

propensity to consume is a very important number in Keynesian theory. MPC is calculated as the<br />

change in consumption divided by the change in income.<br />

MPC = change in consumption ÷ change in income<br />

Example 3: For Example 2A, the MPC is .60, calculated as;<br />

MPC = change in consumption ÷ change in income = $3,000 ÷ $5,000 = .60<br />

The MPC of .60 means that for every additional dollar of income received, households will<br />

consume an additional 60 cents.<br />

The 45° Angle Line<br />

The graph above shows the relationship between consumption and disposable income. It is not<br />

immediately obvious from looking at the graph whether households are saving or dissaving at<br />

different levels of disposable income. The saving or dissaving is easier to see if we draw a line<br />

from the vertex at a 45° angle. This line represents equal amounts of consumption and<br />

disposable income. Where the consumption function intersects with the 45° angle line is the one<br />

level of disposable income where disposable income and consumption are equal.<br />

FOR REVIEW ONLY - NOT FOR DISTRIBUTION<br />

At disposable income levels less than the intersection amount, the consumption function lies<br />

above the 45° angle line, indicating that consumption is greater than disposable income. The<br />

distance between the two lines represents the amount of dissaving. At disposable income levels<br />

C<br />

8 - 3 Keynesian Economic Theory

Hooray! Your file is uploaded and ready to be published.

Saved successfully!

Ooh no, something went wrong!