Final answer:
An increase in disposable income shifts the consumption function upwards, leading to higher consumption but not necessarily in the same proportion due to the marginal propensity to consume being less than one. Other factors, like tax cuts or changes in saving habits, can also shift the consumption function. A rise in income affects the budget constraint and utility, with different effects on consumption of various goods based on preferences.
Step-by-step explanation:
An increase in disposable income typically leads to an increase in consumption because it allows households to spend more without dipping into their savings or borrowing. This phenomenon shifts the consumption function upwards because households now have more income to allocate to consumption versus savings. However, it's important to note that consumption will likely increase by a smaller amount than the increase in disposable income, due to the marginal propensity to consume (MPC) being less than one. This implies that as disposable income increases, the additional amount consumers spend on consumption is less than the increase in their income.
Not only does an increase in disposable income impact consumption, but also several other factors can cause the consumption function to shift. For example, a tax cut that doesn't affect MPC can cause an upward, parallel shift in the consumption function. On the other hand, changes in households' saving preferences that reduce the marginal propensity to save can lead to a steeper consumption function slope, meaning a greater increase in consumption for every additional amount of income.
Moreover, when considering the impact of a rise in income on the budget constraint, it shifts to the right, indicating a higher level of utility for the consumer. The allocation between different goods, such as books and doughnuts in this scenario, depends on the person's preferences and the different marginal utilities derived from each good. The consumption of one might rise significantly while the other might see a modest increase or even a decrease, despite an overall increase in income.