Q.The consumption function of an economy is: C = 40 + 0.8 Y (amount in ₹ crores). Determine that level of income where average propensity to consume will be one.
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🔒 Start your 14-day free trial to unlock the full solution →Part (a)Concept understanding — Marginal Propensity to Consume
Marginal Propensity to Consume (MPC)
Start with everyday intuition
Think about what happens when you get some extra money — say, a ₹500 bonus from your part-time job, or a cash gift on your birthday. You don't save all of it, and you don't spend all of it either. Most people spend a part and save the rest. That part you spend — the fraction of the extra income that goes into consumption — is exactly what economists call the Marginal Propensity to Consume.
The word "marginal" here means "extra" or "additional." So MPC answers one simple question: Out of every extra rupee you earn, how much do you spend?
The precise meaning
Formally, MPC is the ratio of change in consumption expenditure to the change in income that brought it about.
MPC=ΔYΔC
where ΔC = change in consumption, ΔY = change in income.
For example, if your income rises by ₹1,000 and your consumption rises by ₹750, your MPC is 750/1000=0.75 (or 75%). This means you spend 75 paise of every extra rupee and save the remaining 25 paise.
The other side of the coin is the Marginal Propensity to Save (MPS) — the fraction of extra income that is saved. Since every extra rupee is either spent or saved:
MPC+MPS=1
This is not a theory; it's an accounting identity. If MPC = 0.75, then MPS must be 0.25.
Why MPC matters
MPC is not just a number — it is the engine of the multiplier effect, one of the most powerful ideas in macroeconomics.
When someone spends money, that spending becomes someone else's income. That second person, in turn, spends a fraction (their MPC) of that income, which becomes a third person's income, and so on. A single initial injection of spending — say, government investment in a road — ripples through the economy, generating total income many times larger than the original spending.
The size of this ripple depends directly on MPC. The higher the MPC, the larger the multiplier.
Multiplier (k)=1−MPC1=MPS1
If MPC = 0.8, the multiplier is 1/(1−0.8)=5. An initial ₹100 crore investment can generate ₹500 crore of total income. If MPC = 0.5, the multiplier is only 2.
A word on the diagram …
Part (b)Concept understanding — Marginal Propensity to Consume
Marginal Propensity to Consume (MPC)
Start with everyday intuition
Think about what happens when you get some extra money — say, a ₹500 bonus from your part-time job, or a cash gift on your birthday. You don't save all of it, and you don't spend all of it either. Most people spend a part and save the rest. That part you spend — the fraction of the extra income that goes into consumption — is exactly what economists call the Marginal Propensity to Consume.
The word "marginal" here means "extra" or "additional." So MPC answers one simple question: Out of every extra rupee you earn, how much do you spend?
The precise meaning
Formally, MPC is the ratio of change in consumption expenditure to the change in income that brought it about.
MPC=ΔYΔC
where ΔC = change in consumption, ΔY = change in income.
For example, if your income rises by ₹1,000 and your consumption rises by ₹750, your MPC is 750/1000=0.75 (or 75%). This means you spend 75 paise of every extra rupee and save the remaining 25 paise.
The other side of the coin is the Marginal Propensity to Save (MPS) — the fraction of extra income that is saved. Since every extra rupee is either spent or saved:
MPC+MPS=1
This is not a theory; it's an accounting identity. If MPC = 0.75, then MPS must be 0.25.
Why MPC matters
MPC is not just a number — it is the engine of the multiplier effect, one of the most powerful ideas in macroeconomics.
When someone spends money, that spending becomes someone else's income. That second person, in turn, spends a fraction (their MPC) of that income, which becomes a third person's income, and so on. A single initial injection of spending — say, government investment in a road — ripples through the economy, generating total income many times larger than the original spending.
The size of this ripple depends directly on MPC. The higher the MPC, the larger the multiplier.
Multiplier (k)=1−MPC1=MPS1
If MPC = 0.8, the multiplier is 1/(1−0.8)=5. An initial ₹100 crore investment can generate ₹500 crore of total income. If MPC = 0.5, the multiplier is only 2.
A word on the diagram …
Part (a)
APC =YC. It equals one when C=Y (the break-even point, where saving is zero). Substituting the consumption function C=40+0.8Y: …
Part (a): APC = 1 when C = Y; solving 40+0.8Y=Y gives Y=₹200 crores.
Part (b): APS can be negative (dissaving at low income); APC is always positive.
Part (a)
The Average Propensity to Consume (APC) is the ratio of total consumption to total income.
APC=YC
When APC=1, all income is consumed, so C=Y and saving S=0. This is the break-even point.
Substituting the given consumption function C=40+0.8Y (autonomous consumption 40, MPC 0.8) and setting C=Y:
Y=40+0.8Y
Y−0.8Y=40
0.2Y=40
Y=0.240=200 …
- TBSE Tripura Higher Secondary (+2 Stage) Examination (Commerce) 2026Set ANNUAL1 markMCQQ.Which of the following is correct?(a) MPC + MPS = 1(b) 1 − MPC = MPS(c) 1 − MPS = MPC(d) All of the above
›Reveal solutionSolution
MPC + MPS = 1 is the basic identity; 1 − MPC = MPS and 1 − MPS = MPC are just the same equation rearranged — all three options are correct.
Every extra rupee of disposable income (ΔY) that a household receives is, by definition, either consumed or saved: ΔY = ΔC + ΔS. Dividing through by ΔY gives MPC + MPS = 1, where MPC = ΔC/ΔY (marginal propensity to consume) and MPS = ΔS/ΔY (marginal propensity to save). This single identity can be algebraically rearranged in two equivalent ways: 1 − MPC = MPS (subtract MPC from both sides) and 1 − MPS = MPC (subtract MPS from b …
- TBSE Tripura Higher Secondary (+2 Stage) Examination (Commerce) 2026Set ANNUAL1 markQ.If disposable income is Rs. 1000 crore, and the level of consumption is Rs. 800 crore, what will be the average propensity to consume?
›Reveal solutionSolution
APC = C / Y = 800 / 1000 = 0.8.
The Average Propensity to Consume measures what fraction of total disposable income is spent on consumption, calculated as APC = C/Y, where C is the level of consumption expenditure and Y is disposable income. Here, disposable income Y = Rs. 1,000 crore and consumption C = Rs. 800 crore, so:
APC = 800 / 1000 = 0.8
…
- CA Foundation 2025Set may-20251 markMCQQ.Under the Keynesian theory of determination of national income, the assumption is that the consumption increases with an increase in disposable income but the increase in consumption will be _______ the increase in disposable income. (A) Equal to (B) Opposite to (C) Greater than (D) Less than
›Reveal solutionSolution
By Keynes's fundamental psychological law, a rise in income raises consumption by less than the rise in income.
Step 1 — Keynes's psychological law of consumption
Keynes held that as disposable income increases, consumption increases too, but not by the full amount of the increase — people save a part of the additional income.
Step 2 — Express with MPC
The marginal propensity to consume measures the share of extra income that is consumed:
MPC=ΔYΔC,0<MPC<1
Since MPC<1, the change in consumption ΔC is less than the change in disposable income ΔY. …
- CA Foundation 2025Set may-20251 markMCQQ.Which of the following is true in respect of relation of Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS) as per the Keynesian theory of determination of National Income ? (A) MPC = MPS (B) MPC + MPS = 1 (C) MPC + MPS = 0 (D) No relation exists between MPC and MPS
›Reveal solutionSolution
Because extra income is either spent or saved, MPC + MPS = 1.
Step 1 — Split additional income
A change in disposable income (ΔY) is divided between a change in consumption (ΔC) and a change in saving (ΔS):
ΔY=ΔC+ΔS
Step 2 — Divide through by ΔY
ΔYΔC+ΔYΔS=1⇒MPC+MPS=1
So the two marginal propensities always sum to one, and MPS = 1 − MPC.
Why the other options are wrong: (A) MPC = MPS only in the special case where each equals 0.5; it is not a general rule. (C) MPC + MPS = 0 is impossible, since both are non-negative and their sum is 1. (D) A definite relation clearly exists, so 'no relation' is wrong. …
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