Distinguish between average propensity to consume and marginal propensity to consume. An individuals’ average propensity to consume (APC) measures the proportion of their gross income which is spent on consumption, whereas an individuals’ marginal propensity to consume (MPC) is the proportion of each extra dollar of earned income that is/would be spent on consumption. 2.
Consider a person earning $1000 a week who consumes $700 of their income. Suppose that when they receive a 20 percent pay rise, their consumption rises to $800 a week. Calculate: A). their average propensity to consume at their new income level. B). their average propensity to save at their new income level
Initial APC=7000/1000=0.7 A)> after pay rise, APC=800/1200=0.66
Initial APS= 300/1000=0.3
B)>after pay rise, APS= 400/1200=0.33
Therefore, after a 20% pay rise this individual’s APC decreases, and their APS increases.
Now suppose that this person decides to halve the amount of time they spend at work so they can complete a part-time university course. Their income falls to $600 a week. Assuming they have a constant marginal propensity to consume, calculate the following.
A). their new level of consumption. =0.66 (APC) x 600= $400
B). their new level of saving. =0.33 (APS) x 600= $200
Explain how and why savings levels tend to change over the course of a person’s lifetime. Fluctuations in savings levels occur due to different expectations, skills, education and overall income levels at different stages in an individual’s life. Young people tend to receive lower levels of income due to lack of skill, experience and education, therefore increasing their APC and lowering their APS. Once of working age and qualification however, an individual’s income is likely to rise with more serious employment, and their savings therefore increase, as they save for assets such as property and begin accumulating superannuation. In...
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