Final answer:
To compute consumption, savings are added to income; specifically, the base level of consumption (when income is zero) is added to the product of the marginal propensity to consume and income.
Step-by-step explanation:
To compute the equation for consumption, the correct answer is by adding savings to income. In economic terms, consumption and savings are both components of income. The savings function typically has a negative intercept as it accounts for dissavings, or consumption that occurs even when income is zero. As income increases, so does the ability to save, leading to a savings function with a positive slope due to the positive marginal propensity to save.
Example of Calculating Consumption:
Let's consider an income level of $20,000. According to the information provided:
- Start with a base level of consumption that occurs even when income is zero.
- Multiply the income level by the marginal propensity to consume (0.8 in this example).
- Add these two figures together to arrive at total consumption.
In this case:
Consumption = Base consumption + (Marginal propensity to consume × Income)
Consumption = $10,000 + (0.8 × $20,000)
Consumption = $10,000 + $16,000
Consumption = $26,000.
This pattern can be similarly applied across different income levels to calculate consumption. At income levels above a certain threshold (e.g., $50,000 in the provided example), the household will have positive savings. The equation for the consumption function therefore can be summarized as:
Consumption = Autonomous consumption (when income is zero) + (Marginal propensity to consume × Income)