If the marginal propensity to consume (MPC) is 0.8 and disposable income rises by $500, by how much does consumption increase?
A$500 — consumption rises dollar-for-dollar with income
B$400 — consumption rises by MPC times the income change
C$100 — consumption rises by the marginal propensity to save times the income change
D$0 — consumption is determined by autonomous spending, not current income
The consumption function C = a + b×Y_d has slope b = MPC. A change in disposable income ΔY_d causes consumption to change by b × ΔY_d = 0.8 × $500 = $400. The remaining $100 is saved (MPS = 1 − MPC = 0.2). Option A reflects the misconception that MPC = 1; option C confuses MPS with MPC; option D misunderstands autonomous consumption as the only driver of spending.
Question 2 Multiple Choice
In the consumption function C = a + b×Y_d, the intercept 'a' is positive even when disposable income is zero. What does this represent?
AA mathematical artifact — the intercept has no economic meaning when income is zero
BThe amount that government transfers to households when their income falls to zero
CAutonomous consumption — spending on necessities funded by drawing down savings, borrowing, or selling assets even when current income is zero
DThe maximum amount households are willing to consume regardless of income level
Autonomous consumption (the intercept 'a') is the spending that occurs even when current income is zero — people still need food, housing, and other necessities, funded by drawing down savings, selling assets, or borrowing. It is 'autonomous' because it is independent of current income. This is not a mathematical artifact: households do not cut consumption to zero when income temporarily falls, which is one reason recessions do not produce complete economic collapse.
Question 3 True / False
A higher marginal propensity to consume means households save more of each additional dollar of income.
TTrue
FFalse
Answer: False
MPC and MPS are complements that always sum to 1 (MPC + MPS = 1). A higher MPC means households *spend* more of each additional dollar, which necessarily means they save *less*. If MPC = 0.9, then MPS = 0.1 — only 10 cents of each additional dollar is saved. Confusing the direction of this relationship is a common error; MPC measures the consumption fraction, and MPS = 1 − MPC.
Question 4 True / False
The MPC and MPS must always sum to 1 because every dollar of disposable income is either consumed or saved.
TTrue
FFalse
Answer: True
By definition, disposable income (Y_d) is divided entirely between consumption (C) and saving (S): Y_d = C + S. The marginal version of this identity is 1 = MPC + MPS. There is no third category — every additional dollar of disposable income is either spent or set aside as saving. This identity is not an empirical finding but a logical necessity from the definition of disposable income.
Question 5 Short Answer
Why does the Keynesian consumption function include an intercept term (autonomous consumption), and what economic behavior does it capture?
Think about your answer, then reveal below.
Model answer: The intercept captures consumption that occurs independently of current income — people spend on necessities even when income is zero or falls sharply, financed by borrowing, asset sales, or drawing down savings. Without this term, the model would predict zero consumption at zero income, which is empirically false and misses an important stabilizing feature of recessions.
Autonomous consumption explains why recessions don't spiral into complete economic collapse — households maintain some baseline spending regardless of income shocks. It also defines the break-even income level where C = Y_d (saving is zero), and below that point, households are dissaving. Understanding the intercept separates those who grasp the function's economic meaning from those who merely know the algebraic form.