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Homework answers / question archive / Suppose John gets a sales bonus at his place of work that gives him an extra $600 of disposable income

Suppose John gets a sales bonus at his place of work that gives him an extra $600 of disposable income

Economics

Suppose John gets a sales bonus at his place of work that gives him an extra $600 of disposable income. He chooses to spend $360 and save the remaining $240. (a.) From this, you can tell that John's marginal propensity to consume (MPC) is (0.60, 0.40, 0.24, or 0.36), and his marginal propensity to save (MPS) is (0.60, 0.40, 0.24, or 0.36). (b.) Mathematically, it must always be true that: Disposable Income = (Consumption + Savings, Consumption - Savings, or Savings - Consumption). (c.) Therefore, it must also be true that: 1 = (MPC - MPS, MPS - MPC, or MPC + MPS). Explain your answers briefly.

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(a.) From the information given, John's MPC is 0.6. The MPC is defined as follows:

  • MPC = (change in consumption)/(change in disposable income).

In this case:

  • MPC = $360/$600 = 0.6.

(b.) Mathematically, it must always be true that:

  • Disposable Income = Consumption + Savings.

Disposable income is total income minus personal taxes. Consumers can do only two different things with their disposable incomes--consume or save. So, the sums of money allocated to those categories must exhaust disposable income.

(c.) Therefore, it must also be true that:

  • 1 = MPC + MPS.

As noted above:

  • MPC = (change in consumption)/(change in disposable income).

Similarly, the expression for MPS is:

  • MPS = (change in savings)/(change in disposable income).

Adding MPC and MPS together gives:

  • MPC + MPS = (change in consumption)/change in disposable income) + (change in savings)/change in disposable income) = ((change in consumption) + (change in savings))/(change in disposable income) = (change in disposable income)/(change in disposable income) = 1.

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