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Consumption Function Questions and Answers

Keywords: utilization function critique

Consumption function can be an epoch making contribution to the various tools of economic examination analogous to but even more important than Marshall's breakthrough of demand function. Discuss


Consumption function can be explained as the partnership between use and income.

Consumption = f (income) or C = f(y)

Consumption expenditure boosts with increase in income. But increase ingestion is significantly less than increase in income. Consumption will not increase at the same rate as the income will. It is anticipated to psychological behaviour of the individuals.

"As the income of men and women rises, their usage also rises. However the whole increase in income is not became consumption. A part of it is kept. "

In economics, the Hicks-Marshall laws of produced demand assert that, other activities equal, the own-wage elasticity of demand for a category of labour is high under the following conditions:

When the purchase price elasticity of demand for the product being produced is high (level result). So when final product demand is stretchy, an increase in pay will lead to a huge change in the number of the ultimate product demanded affecting job greatly.

When other factors of creation can be easily substituted for the group of labour (substitution impact).

When the way to obtain other factors of production is highly elastic (that is, utilization of other factors of production can be increased without significantly increasing their prices) (substitution effect). That is, employers cannot easily replace labour as doing this will lead to a big upsurge in other factor prices so that it is useless.

Thus, in utilization function we came up to know about consumption costs. But in Marshall's breakthrough we examined about the demand function. So, in economics consumption function is much more better than Marshall's breakthrough of demand function.


If saving decreased sharply in the economy, what would be more likely to happen to investment? Why?


Investment is an addition to the capital stock. It is the thing that basically makes our market go and expand. Income that's not consumed by immediately buying goods and services is kept. The decision to save lots of is linked right to the decision to get. If a nation is to devote a larger show of its development to investment, then it must spend a smaller talk about to consumption, all other things unchanged. And that requires visitors to save more. if keeping falls below investment, it can lead to a rise of aggregate demand and an monetary boom. In the long term if saving falls below investment it eventually reduces investment and detracts from future growth. Future growth is made possible by foregoing present usage to increase investment.

Investment is damaged by the interest; the negative romantic relationship between investment and the interest rate is illustrated by the investment demand curve. The positioning of the curve is influenced by expectations, the amount of economic activity, the stock of capital, the price of capital, the prices of other factors, technology, and general public policy.

Because investment is an element of aggregate demand, a change in investment shifts the aggregate demand curve to the right or remaining. The quantity of the transfer will equal the original change in investment times the multiplier.

In an current economic climate that is shut to the exterior world, investment will come only from the forgone consumption-the saving-of private individuals, private companies, or government. In an open economy, however, investment can surge at the same time a nation's saving is low just because a country can acquire the resources necessary to invest from neighbouring countries.


Suppose the government announces it will pay half of any new investment carried out by firms. How this might affect the investment demand curve?


A visual depiction of the negative connection between investment expenditures and the interest, predicated on the marginal efficiency of investment for different capital investment jobs. Matching to question if administration pay 1 / 2 of any new investment may be capital investment then it'll lead to upsurge in the investment demand curve.

If we think of another 15 years, an extremely substantial part of the investment in all regulated sectors in India is going to come from the private sector. It would be myopic for the federal government to have a regulator who's conflicted, which reduces the quantum of investment and drive up end user charges. It makes more sense for the government to reorganise itself, shifting in to the role of the umpire and from the role of the ball player. We must move towards a simple and clean solution: government as an umpire and the private sector as players

Changes running a business confidence, the costs of capital and demand lead to shifts in the investment demand curve. For example, an increase in export sales abroad might be a rise in the expected rates of return on capital investment and so an outward change of the investment demand curve.


What is the partnership between your marginal and average propensity to take in the standard Keynesian consumption function.



The proportion of every additional dollars of home income that is utilized for consumption expenditures. The marginal propensity to take (abbreviated MPC) is another term for the slope of the use line and is also determined as the change in ingestion divided by the change in income. The MPC takes on a central role in Keynesian economics. It quantifies the consumption-income relation and the essential psychological law. Additionally it is a basis for the slope of the aggregate expenses line and is critical to the multiplier process. A related ingestion measure is the average propensity to consume.

The marginal propensity to consume (MPC) implies what family members sector will with more income. The MPC reveals the part of additional income that can be used for consumption expenses. If, for example, the MPC is 0. 75, then 75 percent of more income goes for usage.

The marginal propensity to take is crucial to the macroeconomy and the study of Keynesian economics. First, the MPC catches induced utilization and the essential psychological regulation of consumer spending proposed by John Maynard Keynes as an integral difference between his Keynesian theory and classical economics. Second, the MPC is the slope of the usage line, rendering it the foundation for the slope of the aggregate expenses range, as well. Third, the MPC affects the multiplier process and affects the magnitude of the expenses and taxes multipliers.

The MPC Formula

The standard formulation for calculating marginal propensity to take (MPC) is:



change in consumption

change in income

This method has a couple of interpretations.

First, it quantifies induced ingestion, that is, how much of each extra buck of income is used for usage. If income changes by $1, then ingestion changes by the worthiness of the MPC. Income induces the change in intake for a price measured by the MPC.

Second, the MPC is actually a measure of the slope of the consumption line. The dimension of slope is normally given as the "rise" in the "run. " For the ingestion line, the surge is the change in use and the run is the change in income.

Average Propensity to Consume

The marginal propensity to consume is one of two measures of the relation between utilization and income. The other is average propensity to consume (APC). Average propensity to consume is the percentage of home income used for usage expenditures. It really is found by dividing use by income.

The solution for determining average propensity to take (APC) looks nearly the same as that for the MPC, but with important variations:





Rather than the CHANGE in consumption divided by the CHANGE in income, the APC measures TOTAL use divided by TOTAL income. In particular, the APC implies how the home sector divides up total income. If, for example, the APC is 0. 9, then 90 of the income received by the household sector is employed for consumption. Moreover, whereas the MPC is constant, the APC actually changes in one income level to the next.


Most economists-and almost all central bankers-seem to think that inflation is costly. But the variety theory asserts that there surely is no long run website link between money and productivity or between inflation and output. Can inflation be expensive if number theory is true?


Yes, if quantity theory holds true inflation can be expensive because we know that there surely is inverse relationship between value of money and price of commodity and value of money and price can describe the number theory of money.

VOM= 1/p

If price of good raises it'll lead to diminish in the value of money.

Similarly, if in the economy there may be inflation, it means the price tag on product will get rise and it'll further lead to diminish in the value of money.

According to amount theory of money there is a direct and proportionate relationship between level of money and standard price level and inverse marriage between level of money and value of money.

Equations of amount theory of money

Transaction approach

Cash balance equation


Constant percentage between loan provider money and Currency money

Money is a medium of exchange

No Hoarding

Full employment

Price level is a passive factor

Constant velocity

Long peroid


The variety theory of money is appropriate in the sense that the amount of prices varies straight with level of money and value of trade aren't changed. To fisher demand for money is perfect for transaction purpose. Value of money, like any other good is set at the main point where demand for money is add up to supply of money.

Consumers need money to buy goods and services. The amount of money is related to the amount of pounds exchanged in ventures. The hyperlink between transactions and money is indicated in the quantity equation.

On the left hand side, "M" is the amount of money, "V" is the speed of money, and "VM" is actually a way of measuring how the money is employed to make deals.


The theory above is dependant on the next hypotheses:

The source of inflation is fundamentally derived from the progress rate of the money supply.

The way to obtain money is exogenous.

The demand for the money, as reflected in its speed, is a stable function of nominal income, interest levels, and so forth.

The mechanism for injecting money into the economy is not that important in the long run.

The real interest rate is determined by non-monetary factors.

Yes, the inflation will high in small amount of time period, yet another thing is it is good for long term only and regarding to this theory if price will high then income increase but it'll create inflation in a nutshell term.


Suppose Intel is considering creating a new chip-making factory.

Assuming that Intel needs to borrow funds in the bond market, why would an increase in rates of interest impacts Intel's decision about whether to build the manufacturer?

ANS:-A) As everybody knows that in the economy there is certainly negative or inverse romantic relationship between investment and rate of interest. So, Investment mainly hinge upon the interest. If interest is high, when compared to a businessman will not invest his money in building a manufacturer.

According to this circumstance, Intel is not having much cash in its hands so it is borrowing money on providing some amount of interest. When the interest is higher, than intel should not do any type of investment in creating a new-chip making stock.

If Intel has enough of its own funds to finance the new manufacturing plant without borrowings, would a rise in interest rates affect still have an impact on Intel's decision about whether to create the manufacturer? Explain

ANS:-B) If Intel has enough of its funds to financing the new stock without borrowings, so regarding to my thoughts and opinions when there is any increase in the interest, it could not impact Intel's decision to build the manufacturer. Intel will do investment to make a new chip-making manufacturer.


Explain the difference between saving and investment as identified by macroeconomist. Which of the following situations stand for investment? Saving? Explain.

Your family takes out a mortgage and buy a fresh house

Your roommate makes $100 and deposits it in her bank account at a bank

You borrow $1000 from standard bank to buy a car to use in your pizza delivery business.


Savings are money or other belongings kept over a long time frame, usually in a bank or investment company without any risk of reduction or making revenue.

Investments are money or other resources purchased with the hope that it'll generate income, reduce costs, or appreciate in the future. In an monetary sense, an investment is the purchase of goods that aren't consumed today but are being used in the foreseeable future to create wealth. In money, an investment is a financial property purchased with the theory that the advantage provides income in the future or appreciate and be sold at an increased price. And usually it has also a threat of some loss

As far once we are discussing investment then it is certain amount of money which is kept or use in some tasks where we can take earnings more than the amount of money we have saved or invested. Generally terms investment means the utilization of money to earn more income.

How Cutting down and Making an investment Differ:

Saving -- Objective: Short-term needs Vehicles Used: Bank or investment company or money market accounts, CD's Risk: None on amounts up to $200, 000. 00 per depositor (FDIC) Gain: Low interest rate. Key Profit: Money is safe and accessible.

Key Downside: Historically comes back havent outpaced inflation. Personal savings are Idle.

Investing -- Objective: Long-term capital expansion Vehicles Used: Stocks and options, bonds, mutual cash, tools, parts, equipment enhancements. Risk: Varies, depending on the way to obtain securities owned. Go back: Interest paid and capital gains earned. Less expensive of production in the future which allows higher net gains in the future. Key Advantage: Earnings have outpaced inflation over the future.

Key Drawback: You can lose cash if securities decline in value.

Getting back to the difference between a saver and an buyer, there may be one term that separates them, which expression is leverage. One definition of leverage is the ability to do more with less. Keeping can be considered a good vehicle for gain, but only since it protects traders from themselves and from incompetent or unscrupulous advisors. The problems that can be made in choosing investments or by holding onto the wrong investment funds can cost us dearly. But choosing ventures well and with them -- that contains the potential for great benefits later.

Your family takes out a mortgage and purchase a new house.

Ans a) Since it is clear that purchasing of any property is an integral part of investment not really a saving because keeping methods to get money store in banks or lockers. So, my children takes out a home loan and buy a fresh house is an investment.

Your roommate earns $100 and debris it in her profile at a bank.

Ans b) Additionally it is clear that anything deposited in a bank is a part of saving not really a investment. So, my roommate makes $100 and he deposited that amount into his account at a standard bank not buying an asset. Here it is savings.

c) You acquire $1000 from bank to buy an automobile to use in your pizza delivery business.

Ans c) It is also an integral part of investment because I borrow $1000 from loan provider to buy an automobile in a desire to earn more by using that car in pizza delivery business.


Using the IS-LM model, show graphically and explain carefully the effects of

An upsurge in authorities spending.

Ans a) What's government spending? This means that government costs. When there can be an upsurge in govt. spending this means that the govt. is doing costs and release the amount of money flow on the market. So, it further expresses that govt. spending business lead to upsurge in money supply and which further business lead to investment and cutting down.

From the diagram of IS-LM curve we may easily understand the relation between IS-LM curve and govt. spending. As govt. spending increased the investment and saving curve is also lead to increase from IS1-IS2.

b. A rise in the amount of money supply

Ans b) Throughout the market we know that if there is demand in the market the price tag on the products and services will results, it'll increase. and when price increase in the market then govt. will boost the money supply in the economy. And which lead to influence the LM curve. An increase in money source always decrease the interest. If there is any upsurge in money supply than, LM curve also contributes to shift rightward. It could be easily explained by making use of diagram that whenever there is no increase in money then LM curve is, LM1 so when money supply boosts then there may be transfer in LM curve from LM1 - LM2.


Consider an market with three policy focuses on: 3 per cent unemployment, 5 per cent rate of inflation and balance of payment equilibrium. Discuss what coverage instruments are available to a federal to attain these focuses on.


1. Monetary Insurance policy

In the UK and US, financial policy is the main tool for keeping low inflation. In the UK, monetary policy is set by the MPC of the lender of Great britain. They are given an inflation aim for by the government. This inflation concentrate on is 2%+/-1 and the MPC use interest levels to try and achieve this focus on.

The first rung on the ladder is perfect for the MPC to forecast future inflation. They look at various financial statistics and try to decide whether the market is overheating. If inflation is forecast to increase above the prospective, the MPC will increase interest rates.

2. Fiscal Insurance plan

This is another demand part policy, similar in effect to Monetary Plan. Fiscal policy includes the federal government changing duty and spending levels, in order to influence the level of Aggregate Demand. To reduce inflationary pressures the federal government can increase taxes and reduce federal spending. This will certainly reduce AD.

3. Exchange Rate Policy

In the overdue 1980s the UK joined up with the ERM, as a means to regulate inflation. It had been felt that by keeping the value of the pound high, it would lessen inflationary pressures. The policy have reduce inflation, but at the price of a recession. To keep up the value of the up against the DM, the federal government had to increase interest levels to 15%. THE UNITED KINGDOM no longer uses this.


There are numerous points from which we can BOP equilibrium, they are :-

Here, IMPORTS will be the major elements of keeping BOP equilbrium because mainly with the effect of this there in unequilbrium. Other factors are Transffer payments, government spendings, Election expenditures etc. . . . . . .

Imports:- The major reason for BOP equilbrium is imports if exports are lower than imports than there may be situation of unequilbrium if we wish equilbrium in INDIA than we must increase our exports. And for this we have to give subsidies to the folks who are producing those ideas that are exported.

Transffer repayments :- In India there are extensive folks who are under below poverty line. Government provided them transffer payment to survive. Nonetheless it is in a large amount that effects balance sheet of administration. i do not need to state that it ought to be remove but it ought to be less according with their bodget.

QUS NO:-10

An current economic climate has full-employment outcome of 9000, and federal buys are 2000. Desired consumption and desired investment are the following:

Real interest Desired consumption Desired investment

2 6100 1500

3 6000 1400

4 5900 1300

5 5800 1200

6 5700 1100

Why do desired consumption and desired investment fall season as real interest rate rises?

ANS NO:-10

Desired consumption falls as real interest goes up will be discussed with the partnership between intake and rate of interest.

Consumption function identifies the functional marriage between aggregate use and aggregate income C = f(y). The program shows the various amount of ingestion at various levels of income. This shows that when income increases, consumption also enhances, but in a smaller percentage (i. e. ) the percentage of income spent on consumption continues on slipping as income raises. A part of additional income is not consumed and is also therefore preserved.

Rate appealing: If the interest is high, then people will forgot today's intake and postpone it for another date. Higher the interest payable, reduced will be purchasing vitality. This will certainly reduce the intake.

Desired investment comes as real interest increases will be discussed with the partnership between Investment and rate of interest.

Mainly we know that there surely is the inverse romance between investment and interest throughout the market. It could be described with the example, which i borrow $2000 for purchase a car on which standard bank has allowed 15% rate of interest which is a lot higher. So, I have to pay $300 as interest which is large amount for me personally. After doing all this calculations I had formed take important decision that I will not invest money on purchasing a car.

The financial commitment is a marginal benefit-marginal cost decision

The marginal benefit from investment is the expected rate of return (r)

The marginal cost is the interest (i) that must definitely be paid for borrowed funds; the two will be the determinants of

investment spending.

An investment is manufactured if the expected rate of come back exceeds the interest (r > i). Investments are not made when interest rate surpasses the expected rate of come back (r < i)

Expected rate of come back:

Businesses only make investments when they be prepared to recieve gains.

r = (TR - cost of investment) / cost of investment.

Firms are risk takers. therefore, can't promise profits.

Firms have to think about expected rate of come back must be greater than the real interest rate.

The real interest rate:

Business only commit when the speed of go back is greater than the interest (r>i)

Ex: Taking right out financing for a 1000 dollars machine. When the interest is 7%, you pay $70 us dollars in interest (1000 x 0. 07). In case the rate of go back is 10%, then you gain $100 from purchasing the machine (1000 x 0. 1).

Your net revenue is $30 ($100-$70)

Notice that the rate of return > interest rate, which means investment is worth it.

Real interest = Nominal INTEREST - Inflation

Interest cost= interest x cost.

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