Explain how each of the following events influences the U.S. consumption function:
- The marginal propensity to consume decreases.
- U.S. autonomous consumption decreases.
- Americans expect an increase in future income.
The correct answer and explanation is :
How Each Event Influences the U.S. Consumption Function
1. The Marginal Propensity to Consume (MPC) Decreases
The marginal propensity to consume (MPC) represents the fraction of additional income that households spend on consumption rather than saving. When MPC decreases, consumers choose to save a greater portion of any additional income rather than spending it. This results in a flatter consumption function, meaning that increases in income will lead to a smaller increase in total consumption. Consequently, overall consumption in the economy grows at a slower rate, reducing the multiplier effect on GDP.
2. U.S. Autonomous Consumption Decreases
Autonomous consumption refers to the portion of total consumption that occurs regardless of income levels. It reflects spending on necessities such as food, housing, and healthcare, even when income is zero. A decrease in autonomous consumption indicates that consumers are cutting back on their basic spending, possibly due to economic uncertainty, higher interest rates, or reduced access to credit. This shift lowers the entire consumption function, meaning that for any given level of income, total consumption will be lower. This could lead to weaker aggregate demand, slowing down economic growth.
3. Americans Expect an Increase in Future Income
Expectations about future income play a crucial role in consumption behavior. According to the Permanent Income Hypothesis and Life-Cycle Hypothesis, individuals base their current spending decisions on expected future earnings. If Americans anticipate higher future income, they are likely to increase their current consumption, even if their present income remains unchanged. This leads to an upward shift in the consumption function as households become more willing to spend in anticipation of higher earnings. Increased consumption can boost demand, leading to economic expansion.
In summary, a lower MPC slows consumption growth, decreased autonomous consumption shifts the function downward, and higher future income expectations push consumption upward.