In economics, the concept of propensity to consume refers to the

Question

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.    1 
 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.

2 
 2. According to the passage, Keynesian multipliers should be larger for permanent changes in income than for temporary changes in income because:

A. The distinction between permanent and temporary is often difficult to categorize.
B. Consumers are more likely to spend temporary income than permanent income.
C. The prevailing interest rate is an important factor that consumers generally consider when deciding to spend temporary income.
D. Consumers have less incentive to increase their consumption due to temporary income than due to permanent income.
E. Average propensity to consume is less variant than marginal propensity to consume.

3 
 3. The primary purpose of the passage is to:

A. Predict that marginal propensity to consume is higher for permanent income than for temporary income.
B. Explain how the standard Keynesian model differentiates between marginal propensity to consume and average propensity to consume.
C. Argue that marginal propensity to consume converges with average propensity to consume as incomes become substantially higher.
D. Explain the concept of marginal propensity to consume and its variance among different types and levels of income.
E. Detail the implication of higher income and wealth levels on a household’s marginal propensity to consume.

Sajjad1994 · Accepted Answer

Official Explanation

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

Difficulty Level:   Hard

Explanation

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.

Answer: C

2. According to the passage, Keynesian multipliers should be larger for permanent changes in income than for temporary changes in income because:

Difficulty Level:   Easy

Explanation

In this Specific question, return to the passage looking for a paraphrase of an answer choice. In paragraph three, you’ll find the line  “…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…”  This shows the cause-and-effect of the Keynesian multiplier’s being larger for permanent changes; when income changes are permanent, consumers have more incentive to increase consumption, meaning that they have less incentive to increase due to temporary income increases. This is essentially a paraphrase of answer choice D.

Answer: D

3. The primary purpose of the passage is to:

Difficulty Level:   Medium

Explanation

Looking at the flow of this passage, the  first paragraph  outlines the idea of propensity to consume and MPC; the  second paragraph  talks about the difference between short- and long-run MPC; and the third talks about permanent income vs. temporary income and how each affects MPC. Therefore, the main point of the passage is to explain MPC and how different types of income affects it.

Choices A, B,  and  C  each appear in the passage, but are details, not main points.

Choice E  is incorrect, similarly, because of the word  “detail”  – the passage is a general overview but not detailed, and the specific points of  “higher income and wealth levels”  is a small portion of what the passage covers.

Answer: D

Neha2404 · Answer

Imo-C

Short-term decreases in income do not lead to reductions in consumption, because people reduce savings to stabilize consumption
According to above lines 
MPC= consumption/income
In short term income is decrease and consumption will be stable 
Means MPC Will be increase

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

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

Imo-D

because if consumers expect a change in income to be permanent, then they have a greater incentive to increase their consumption.

2. According to the passage, Keynesian multipliers should be larger for permanent changes in income than for temporary changes in income because:

A. The distinction between permanent and temporary is often difficult to categorize.- incorrect 
B. Consumers are more likely to spend temporary income than permanent income.-incorrect 
C. The prevailing interest rate is an important factor that consumers generally consider when deciding to spend temporary income.-incorrect 
D. Consumers have less incentive to increase their consumption due to temporary income than due to permanent income.-correct 
E. Average propensity to consume is less variant than marginal propensity to consume-incorrect

Imo-D

Main point
Para-1- explain MPC
Para-2-explain Standard keynesian model for short term and long term
Para -3- explain keyanesian multipler and temporary and permanent change in income and its impact on MPC

3. The primary purpose of the passage is to:

A. Predict that marginal propensity to consume is higher for permanent income than for temporary income.- incorrect - it is mentioned only in 3para 
B. Explain how the standard Keynesian model differentiates between marginal propensity to consume and average propensity to consume.-incorrect - it is mentioned in 3rd para
C. Argue that marginal propensity to consume converges with average propensity to consume as incomes become substantially higher.incorrect 
D. Explain the concept of marginal propensity to consume and its variance among different types and levels of income.-correct 
E. Detail the implication of higher income and wealth levels on a household’s marginal propensity to consume.-incorrect

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Tahamohsin · Answer

1. According to the passage, it can be inferred that: 
 C 
A. When a household’s income increases, its marginal propensity to consume decreases.
 It states opposite 
B. Most households cannot accurately delineate between permanent and temporary changes in income.
 The passage stated that delineating between permanent and temporary changes in income is difficult, but it did not state that it is done by the household. 
C. Decreases in income generally lead to short-run increases in marginal propensity to consume.
 Honest only this one left; I was able to eliminate all other 
D. Early Keynesian analyses did not allow for a Keynesian multiplier for income changes with regard to marginal propensity to consume.
 The passage actually stated that Keynesian analyses ignored subtleties between permanent changes and temporary changes. 
E. In the short run, it is impossible for a household to have a negative marginal propensity to consume.
 Impossible- make this choice extreme

2. According to the passage, Keynesian multipliers should be larger for permanent changes in income than for temporary changes in income because: 
 D 
 The passage stated if consumers expect a change in income to be permanent, then they have a greater incentive to increase their consumption. 
A. The distinction between permanent and temporary is often difficult to categorize.
 Not the answer. 
B. Consumers are more likely to spend temporary income than permanent income.
 No such comparison was made in the passage 
C. The prevailing interest rate is an important factor that consumers generally consider when deciding to spend temporary income.
 Talking about the wrong detail. 
D. Consumers have less incentive to increase their consumption due to temporary income than due to permanent income.
 Correct, if consumers expect a change in income to be permanent, then they have a greater incentive to increase their consumption  
E. Average propensity to consume is less variant than marginal propensity to consume.
 Out of scope.

3. The primary purpose of the passage is to: 
 D 
A. Predict that marginal propensity to consume is higher for permanent income than for temporary income.
 Only the first and second para talk about this, not the whole passage.  
B. Explain how the standard Keynesian model differentiates between marginal propensity to consume and average propensity to consume.
 Detail from third para,  
C. Argue that marginal propensity to consume converges with average propensity to consume as incomes become substantially higher.
 Detail from the second para 
D. Explain the concept of marginal propensity to consume and its variance among different types and levels of income.
 Correct; this choice covers the whole passage 
E. Detail the implication of higher income and wealth levels on a household’s marginal propensity to consume.
 Wrong

RahulHGGmat · Answer

Hi Expert,

Hope you are doing well.

I am confused between options B and C for question number 1. I opted for B and was wrong.

Sajjad1994  has already provided an explanation why C is correct and I indeed agree with him. However, I am unable to understand why B is incorrect. Hence, I would request you to affirm me the reason for the same.

Many Thanks in advance.

bM22 · Answer

Hi  RahulHGGmat ,

What's mentioned in the passage : "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.", but we still cannot infer if households find it difficult to designate a particular change in income as being permanent or temporary. Thus B is incorrect.

Hope This Helps.
Thanks.

VerbalBot · Answer

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In economics, the concept of propensity to consume refers to the

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In economics, the concept of propensity to consume refers to the

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