Given that the marginal propensity to consume (MPC) is larger, which of the following statements are true? (i) Marginal propensity to save will be larger (ii) Multiplier value will be larger (iii) Average propensity to consume will be larger (iv) Autonomous consumption will be higher

Question

Accepted Answer

The correct option is 2: Both (ii) and (iii)

The Marginal Propensity to Consume (MPC) measures the proportion of an increase in income that is spent on consumption. When MPC is larger, it means households spend a greater fraction of any additional income they receive. This higher rate of re-spending significantly impacts the economy in two ways, confirming statements (ii) and (iii). Firstly, the Multiplier (k) is inversely related to the Marginal Propensity to Save (MPS) and directly related to MPC, as defined by the formula $k = 1/(1 - 	ext{MPC})$. If MPC is larger, the denominator (1 - MPC, which is MPS) is smaller, leading to a larger multiplier value. This means any initial injection of spending (investment or government expenditure) will generate a much larger increase in total income. Secondly, a larger MPC implies that the average propensity to consume (APC), which is the ratio of total consumption to total income, will also be larger, assuming consumption is a linear function of income (C = a + bY, where b = MPC). As the slope of the consumption function (MPC) increases, the consumption line rotates upwards, increasing the share of income consumed (APC) at any given income level, except where C = a.

The incorrect option is 1: Both (i) and (ii)

Statement (i) Marginal propensity to save (MPS) will be larger is incorrect. The relationship between MPC and MPS is given by $	ext{MPC} + 	ext{MPS} = 1$. Since they must sum to one, if the MPC is larger, the MPS must necessarily be smaller. Therefore, a large MPC implies a small MPS.

The incorrect option is 3: (i), (ii) and (iii)

Statement (i) is incorrect, as explained above (if MPC is larger, MPS must be smaller). Statements (ii) and (iii) are correct.

The incorrect option is 4: (ii), (iii) and (iv)

Statement (iv) Autonomous consumption will be higher is incorrect. Autonomous consumption (the intercept 'a' in the consumption function C = a + bY) refers to the consumption that occurs even when income is zero. It is determined by non-income factors such as wealth, consumer confidence, or expectations. It is not mechanically linked to the Marginal Propensity to Consume (MPC), which is the slope 'b' of the consumption function. MPC refers to the *change* in consumption due to a *change* in income, independent of the initial level of autonomous consumption.