Consider a closed economy in which consumption equals $500 billion when real GDP equals zero, and consumption increases by 75 cents when disposable income increases by $1

Economics Dec 17, 2020

Consider a closed economy in which consumption equals $500 billion when real GDP equals zero, and consumption increases by 75 cents when disposable income increases by $1. Investment is constant for all levels of real GDP and equal to $200 billion. In this economy, what is the marginal propensity to save (MPS)?

Expert Solution

MPC is defined as the proportion of each dollar of income that households choose to spend. In this situation, the MPC is 0.75 because consumption increases by $0,75 when disposable income increases by $1. Every dollar that is not consumed is by definition saved, Therefore, the marginal propensity to save (MPS) = 1 - MPC = 1 - 0.75 = 0.25.

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