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Explain why the MPC and the MPS must always add up to one.

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MPC and MPS describe consumer's tendencies to fully utilize their income. MPC relates to consumption tendency while MPS to saving tendency.

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Explain why the MPC and the MPS must always add up to one.

MPC (Marginal Propensity to Consume) means extra consumption from an extra dollar of income.
And, MPS (Marginal Propensity to Save) means extra saving from an extra dollar of income.
That ...

Solution Summary

MPC and MPS describe consumer's tendencies to fully utilize their income. MPC relates to consumption tendency while MPS to saving tendency.

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GDP, Multiplier Effect, AS/AD Framework help

1. Which of the following are included in this year's GDP? Explain your answer in each case.

a. Interest on an AT&T corporate bond.

b. Social security payments received by a retired factory worker.

c. The unpaid services of a family member in painting the family home.

d. The income of a dentist.

e. The money received by Smith when she sells her economics textbook to a book buyer.

f. The monthly allowance a college student receives from home.

g. Rent received on a two‑bedroom apartment.

h. The money received by Josh when he resells his current-year-model Honda automobile to Kim.

i. The publication of a college textbook.

j. A 2‑hour decrease in the length of the workweek.

k. The purchase of an AT&T corporate bond.

l. A $2 billion increase in business inventories.

m. The purchase of 100 shares of GM common stock.

n. The purchase of an insurance policy by Patsy Prune.

2. What is the multiplier effect? What will the multiplier be when the MPS is 0, .4, .6, and 1? What will it be when the MPC is 1, .9, .67, .5, and 0? How much of a change in GDP will result if firms increase their level of investment by $8 billion and the MPC is .80? If the MPC is .67?

3. Patsy Prune had a question on an assignment which stated the following:

"Suppose the Federal Reserve decided to reduce the interest rates or the Fed Funds rate. Demonstrate what will happen to the price level and the level of output using the AS/AD framework."

Patsy wrote the following in her answer: The AD will shift to the right causing an increase in the price and the level of output in the short-run. At the same time the AS will shift to the left because of higher prices. Output will increase and the price level increase as well in the long-run. So in the long-run both output and price will increase.

Is Patsy correct in her reasoning? Explain and be sure to use a graph to explain your answer.

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