As disposable income increases, consumption demand is expected to

Question

BlackTom AI · Accepted Answer

The consumption function relates disposable income (Yd) to consumption (C). In standard Keynesian theory C = a + bYd, where a is autonomous consumption and b (the marginal propensity to consume, MPC) is between 0 and 1. Because MPC > 0, an increase in disposable income raises consumption.

Step-by-step reasoning:
1. Relevant concepts: disposable income (income after taxes), consumption function, autonomous consumption, and MPC. MPC measures how much of an additional dollar of disposable income is spent rather than saved.
2. The general equation: C = a + bYd, with 0 < b < 1. If Yd increases by ΔYd, consumption changes by ΔC = b × ΔYd.
3. Numerical example showing intermediate steps:
   - Let a = $100 (autonomous consumption) and b = 0.8 (MPC).
   - Initial disposable income Yd1 = $1,000 → C1 = 100 + 0.8(1,000) = 100 + 800 = $900.
   - Suppose disposable income rises by ΔYd = $100 to Yd2 = $1,100 → C2 = 100 + 0.8(1,100) = 100 + 880 = $980.
   - Change in consumption ΔC = C2 − C1 = $980 − $900 = $80, which equals b × ΔYd = 0.8 × $100.
4. Interpretation: consumption increases when disposable income increases, though typically by less than the full income increase because some of the additional income is saved (MPC < 1).

Why the other options are incorrect:
- b. decrease: Contradicts the positive MPC; higher disposable income does not lead to lower consumption on average.
- c. remain the same: Would imply MPC = 0, which is not consistent with empirical behavior (people typically spend some of any additional income).
- d. none of the above: Not correct because option (a) correctly states the expected relationship.

Conclusion: Because the marginal propensity to consume is positive, consumption demand is expected to increase as disposable income increases. This confirms the correct answer: a. increase.

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