Question

Suppose that consumption is $500 and that the marginal propensity to consume is 0.4. If disposable income increases by $200, how much will saving increase by?

Answer 1

The marginal propensity to consume (MPC) is the fraction of a change in disposable income that is spent on consumption. If the MPC is 0.4, then 40% of any increase in disposable income will be spent on consumption and the remaining 60% will be saved.

Given that consumption is $500 and disposable income increases by $200, the new level of disposable income is $500 + $200 = $700. The increase in disposable income is $200, so the increase in consumption is 0.4 x $200 = $80. The remaining $120 ($200 - $80) will be saved.

Therefore, saving will increase by $120.