If Marginal Propensity to Save is 20% and is constant at all levels of income and the autonomous consumption i

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Q. If Marginal Propensity to Save is 20% and is constant at all levels of income and the autonomous consumption is ₹100 crores, construct consumption function of the given hypothetical economy.

Yanam CbseCBSE Class XII Board 2019Subjective· 3mImportance★★★★★

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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 = \frac{\Delta C}{\Delta Y}

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) = \frac{1}{1 - MPC} = \frac{1}{MPS}

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 …

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The consumption function shows how total consumption relates to income; given autonomous consumption and marginal propensity to save, we derive the marginal propensity to consume to construct the function as $C = 100 + 0.8Y$ .

The consumption function is a core concept in macroeconomics, illustrating the relationship between total consumption expenditure and disposable income. It's a fundamental building block for understanding aggregate demand and equilibrium in an economy. The function essentially tells us how much an economy's households plan to spend on goods and services at different levels of income.

The economic intuition behind the consumption function is that people consume a certain minimum amount even if their income is zero (this is called autonomous consumption), and beyond that, their consumption increases as their income increases. However, they typically do not consume all of their additional income; a portion is saved. The rate at which consumption changes with income is captured by the Marginal Propensity to Consume (MPC).

The general form of the linear consumption function is given by:

C = c_0 + bY

We are given the following information for the hypothetical economy:

Marginal Propensity to Save (MPS) = 20%
Autonomous Consumption ( $c_0$ ) = ₹100 crores

To construct the consumption function, we need to find the value of the Marginal Propensity to Consume ( $b$ ). We know that the sum of the Marginal Propensity to Consume (MPC) and the Marginal Propensity to Save (MPS) is always equal to 1. This is because any additional unit of income is either consumed or saved. …

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Same / Similar Concept — real previous-year questions on the same or a closely similar concept, not this exact question.

CA Foundation 2025Set may-20251 markMCQ
$Q. Under the Keynesian theory of determination of national income, the assumption is that the consumption increases with an increase in disposable income but the increase in consumption will be _______ the increase in disposable income. (A) Equal to (B) Opposite to (C) Greater than (D) Less than$
›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:
$MPC = \frac{\Delta C}{\Delta Y}, \qquad 0 < MPC < 1$
Since $MPC < 1$ , the change in consumption $\Delta C$ is less than the change in disposable income $\Delta Y$ . …
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CA Foundation 2025Set may-20251 markMCQ
$Q. Which of the following is true in respect of relation of Marginal Propensity to Consume (MPC) and Marginal Propensity to Save (MPS) as per the Keynesian theory of determination of National Income ? (A) MPC = MPS (B) MPC + MPS = 1 (C) MPC + MPS = 0 (D) No relation exists between MPC and MPS$
›Reveal solutionSolution

Because extra income is either spent or saved, MPC + MPS = 1.

Step 1 — Split additional income

A change in disposable income ( $\Delta Y$ ) is divided between a change in consumption ( $\Delta C$ ) and a change in saving ( $\Delta S$ ):
$\Delta Y = \Delta C + \Delta S$
Step 2 — Divide through by $\Delta Y$
$\frac{\Delta C}{\Delta Y} + \frac{\Delta S}{\Delta Y} = 1 \;\Rightarrow\; MPC + MPS = 1$
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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Q.If Marginal Propensity to Save is 20% and is constant at all levels of income and the autonomous consumption is ₹100 crores, construct consumption function of the given hypothetical economy.

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