Question

The saving curve makes an intercept of 40 crores on the negative Y-axis. If consumers spend 60% of additional income, then determine: (i) Saving Function; (ii) Consumption Function; (iii) Break-even level of income.
((i) S = -40 + 0.40Y; (ii) c = 40 + 0.60 Y; Rs.100 crores)

Answer 1

(i) Savings function refers to the standard equation of savings which defines the relationship between savings and income where savings value can be derived at each level with the use of income value.

S= s + Y(1-b) where s=autonomous savings, (1-b)= marginal propensity to save, and Y= income.

Autonomous savings= 40 crores and if consumer spends 60% of the income, then they save 40%. So, MPS= 0.4

S= - 40 + 0.4 Y where 40 crores=autonomous savings, 0.4= marginal propensity to save, and Y= income.

(ii) Consumption function refers to the standard equation of consumption which defines the relationship between consumption and income where consumption value can be derived at each level with the use of income value.

C= c+ bY where c=autonomous consumption, b= marginal propensity to consume, and Y= income.

if S= -40+0.4 Y

C+S=Y

=> C = Y-S

= Y - (-40+0.4Y)

= Y + 40 - 0.4 Y

= 40 + 0.6 Y

Hence, C = 40 + 0.6 Y where autonomous consumption = 40 crores , MPC= 0.6 and Y= income.

(iii) Break even level of income refers to that income where the income=consumption or savings= 0. Therefore,

Y=C

=> Y= 40 +0.6 Y

=> Y- 0.6 Y=40

=> 0.4 Y = 40

=> Y= 40/0.4 = Rs. 100 crores.