GMAT Question of the Day: Daily via email | Daily via Instagram New to GMAT Club? Watch this Video

 It is currently 28 Mar 2020, 21:54

### GMAT Club Daily Prep

#### Thank you for using the timer - this advanced tool can estimate your performance and suggest more practice questions. We have subscribed you to Daily Prep Questions via email.

Customized
for You

we will pick new questions that match your level based on your Timer History

Track

every week, we’ll send you an estimated GMAT score based on your performance

Practice
Pays

we will pick new questions that match your level based on your Timer History

# In economics, the concept of “propensity to consume” refers to the pro

Author Message
TAGS:

### Hide Tags

Senior SC Moderator
Joined: 14 Nov 2016
Posts: 1342
Location: Malaysia
In economics, the concept of “propensity to consume” refers to the pro  [#permalink]

### Show Tags

Updated on: 26 Sep 2019, 00:10
1
2
Question 1
00:00

based on 241 sessions

29% (03:36) correct 71% (03:37) wrong

### HideShow timer Statistics

In economics, the concept of “propensity to consume” refers to the proportion of disposable income – income after taxes and transfers – that individuals spend on consumption. Marginal propensity to consume (MPC) is a related metric that quantifies induced consumption, the idea that as income increases a consumer’s consumption will also increase. MPC is the proportion of that additional income that an individual consumes; for example, if a household earns one extra dollar of disposable income, and the marginal propensity to consume is 0.65, then of that dollar, the household will spend 65 cents and save 35 cents.

In a standard Keynesian model, the MPC will be less than the average propensity to consume (APC) because in the short-run some (autonomous) consumption does not change with income. Short-term decreases in income do not lead to reductions in consumption, because people reduce savings to stabilize consumption. Over the long-run, as wealth and income rise, consumption also rises; the marginal propensity to consume out of long-run income is closer to the average propensity to consume.

Economists often distinguish between the marginal propensity to consume out of permanent income and the marginal propensity to consume out of temporary income, because if consumers expect a change in income to be permanent, then they have a greater incentive to increase their consumption. This implies that the Keynesian multiplier – the measure of that consumption’s impact on additional consumption in the marketplace – should be larger in response to permanent changes in income than it is in response to temporary changes in income (though the earliest Keynesian analyses ignored these subtleties). However, the distinction between permanent and temporary changes in income is often subtle in practice, and it is often quite difficult to designate a particular change in income as being permanent or temporary. What is more, the marginal propensity to consume should also be affected by factors such as the prevailing interest rate and the general level of consumer surplus that can be derived from purchasing.

Spoiler: :: OA&OE
C. In this Inference question, it can be inferred from the passage (in paragraph 2) that short-term decreases in income force people to increase their consumption relative to earnings, as you’re told that consumption does not decrease in the short-run. This, then would mean that the ratio of consumption to earnings goes up, therefore increasing MPC.

Question ID: 09960
1. According to the passage, it can be inferred that:

(A) When a household’s income increases, its marginal propensity to consume decreases.
(B) Most households cannot accurately delineate between permanent and temporary changes in income.
(C) Decreases in income generally lead to short-run increases in marginal propensity to consume.
(D) Early Keynesian analyses did not allow for a Keynesian multiplier for income changes with regard to marginal propensity to consume.
(E) In the short run, it is impossible for a household to have a negative marginal propensity to consume.

_________________
"Be challenged at EVERY MOMENT."

“Strength doesn’t come from what you can do. It comes from overcoming the things you once thought you couldn’t.”

"Each stage of the journey is crucial to attaining new heights of knowledge."

Originally posted by hazelnut on 10 Oct 2017, 04:51.
Last edited by SajjadAhmad on 26 Sep 2019, 00:10, edited 1 time in total.
Updated - Complete topic (675).
Intern
Joined: 04 Sep 2017
Posts: 11
Re: In economics, the concept of “propensity to consume” refers to the pro  [#permalink]

### Show Tags

25 Oct 2017, 10:46
5
nairaneesh wrote:
I am confused because MPC is applicable only when additional income comes in to play.

Read this line in the second paragraph - "Short-term decreases in income do not lead to reductions in consumption, because people reduce savings to stabilize consumption."
Earlier, if Income was \$1000 and MPC was 0.72 (consumption 1000* 0.72 = \$720), and now if the income falls to \$800, the consumption remains same, then the MPC increases to 0.9 (720/800).

Hope this helps!
##### General Discussion
Intern
Joined: 28 Apr 2017
Posts: 35
Re: In economics, the concept of “propensity to consume” refers to the pro  [#permalink]

### Show Tags

25 Oct 2017, 10:30
1
The passage talks about MPC, APC and consumption and how they are related.
In between B and C. I kept B as an option as I read through it. Passage says it is difficult to differentiate but it doesn't mention that it is for household...so kept on hold
Option C.. It says when income reduces in short run consumption remains same..that means savings are reduced and a greater proportion of income is dedicated to consumption. Hence option C.

Kudos if you like the explanation.
Senior Manager
Joined: 09 Feb 2015
Posts: 323
Location: India
Concentration: Social Entrepreneurship, General Management
GMAT 1: 690 Q49 V34
GMAT 2: 720 Q49 V39
GPA: 2.8
Re: In economics, the concept of “propensity to consume” refers to the pro  [#permalink]

### Show Tags

03 Nov 2017, 22:53
Sprincejindal wrote:
nairaneesh wrote:
I am confused because MPC is applicable only when additional income comes in to play.

Read this line in the second paragraph - "Short-term decreases in income do not lead to reductions in consumption, because people reduce savings to stabilize consumption."
Earlier, if Income was \$1000 and MPC was 0.72 (consumption 1000* 0.72 = \$720), and now if the income falls to \$800, the consumption remains same, then the MPC increases to 0.9 (720/800).

Hope this helps!

I agree with what you say but the very definition of MPC is that additional income that the family consumes. So if there is a decrease in income ,the MPC will be negative no ?

I think if the answer choice were to be rephrased, Decreases in income generally lead to short-run increases in propensity to consume. Choice c would be right.
Intern
Joined: 04 Sep 2017
Posts: 11
Re: In economics, the concept of “propensity to consume” refers to the pro  [#permalink]

### Show Tags

04 Nov 2017, 03:20
2
goforgmat wrote:
Sprincejindal wrote:
nairaneesh wrote:
I am confused because MPC is applicable only when additional income comes in to play.

Read this line in the second paragraph - "Short-term decreases in income do not lead to reductions in consumption, because people reduce savings to stabilize consumption."
Earlier, if Income was \$1000 and MPC was 0.72 (consumption 1000* 0.72 = \$720), and now if the income falls to \$800, the consumption remains same, then the MPC increases to 0.9 (720/800).

Hope this helps!

I agree with what you say but the very definition of MPC is that additional income that the family consumes. So if there is a decrease in income ,the MPC will be negative no ?

I think if the answer choice were to be rephrased, Decreases in income generally lead to short-run increases in propensity to consume. Choice c would be right.

MPC is not the additional income that a family consumes, but it is the proportion of that additional income that a family consumes. It is the ratio of changes in consumtion to changes in income. So when the income (Denominator) reduces, but the consumption (Numerator) remains the same, then the MPC (Ratio) increases.
Intern
Joined: 13 Feb 2017
Posts: 5
Location: India
Schools: ISB '21
Re: In economics, the concept of “propensity to consume” refers to the pro  [#permalink]

### Show Tags

28 Dec 2018, 06:51
nairaneesh wrote:
I am confused because MPC is applicable only when additional income comes in to play.

Read this line in the second paragraph - "Short-term decreases in income do not lead to reductions in consumption, because people reduce savings to stabilize consumption."
Earlier, if Income was \$1000 and MPC was 0.72 (consumption 1000* 0.72 = \$720), and now if the income falls to \$800, the consumption remains same, then the MPC increases to 0.9 (720/800).

Hope this helps![/quote]

I agree with what you say but the very definition of MPC is that additional income that the family consumes. So if there is a decrease in income ,the MPC will be negative no ?

I think if the answer choice were to be rephrased, Decreases in income generally lead to short-run increases in propensity to consume. Choice c would be right.
[/quote]

But inst the MPC calculated on the additional income and not the total income. So if the current income is say, €1000, what can be calculated is the APC. If the income increases by say, €200, then, MPC would be calculable only in the €200 and not €1200. This is what I am inferring.

I understand this is not the learning from this GMAT question, but only curios to understand the solution.

Posted from my mobile device
Manager
Joined: 03 Nov 2018
Posts: 72
Location: India
Schools: LBS '21
GMAT 1: 580 Q44 V28
GMAT 2: 580 Q44 V28
GPA: 3.44
Re: In economics, the concept of “propensity to consume” refers to the pro  [#permalink]

### Show Tags

22 Jan 2020, 21:27
Intern
Joined: 03 Jan 2019
Posts: 1
Location: India
GMAT 1: 670 Q50 V30
GPA: 3.28
Re: In economics, the concept of “propensity to consume” refers to the pro  [#permalink]

### Show Tags

23 Jan 2020, 17:55
I am confused among options B, C and D

Quote:
Read this line in the second paragraph - "Short-term decreases in income do not lead to reductions in consumption, because people reduce savings to stabilize consumption."
Earlier, if Income was \$1000 and MPC was 0.72 (consumption 1000* 0.72 = \$720), and now if the income falls to \$800, the consumption remains same, then the MPC increases to 0.9 (720/800).
As said by Sprincejindal above, I understand why option C is correct.

Quote:
However, the distinction between permanent and temporary changes in income is often subtle in practice, and it is often quite difficult to designate a particular change in income as being permanent or temporary.
From the quote above, in option B, the passage suggests that it is quite difficult to designate a particular change, but doesn't say that it is the household that are unable to designate a change in income. Hence option B is also ruled out.

Quote:
This implies that the Keynesian multiplier – the measure of that consumption’s impact on additional consumption in the marketplace – should be larger in response to permanent changes in income than it is in response to temporary changes in income (though the earliest Keynesian analyses ignored these subtleties).
. But when it comes to option D, according to the sentence above, we see that the earlier Keynesian analyses did not account for differences in permanent changes in income and temporary changes in income. And these income changes affect the MPC. Hence shouldn't option D be right?
Re: In economics, the concept of “propensity to consume” refers to the pro   [#permalink] 23 Jan 2020, 17:55
Display posts from previous: Sort by