Chapter P4, Problem 1KC

To determine

 The reason that will not cause the shift in the consumption function.

Answer to Problem 1KC

Option 'd' is correct.

Explanation of Solution

The economic growth is the increase in the inflation adjusted market value of goods and services in the economy over a time period. The main element that helps to the economic growth is the consumption of the goods and the services by the consumers. The consumption is done on the basis of the disposable income of the consumers and the relation between the consumption and the disposable income of the consumers is known as the consumption function.

Option (d):

When there is a change in the disposable income of households, there will be changes in the consumption pattern of a consumer. When the disposable income increases, it increases the quantity demanded and when the disposable income decreases, it decreases the quantity demanded. This means that there will be a movement along the same consumption function and there will be no shift in the consumption function. Hence, option 'd' is correct.

Option (a):

For example, when the real assets change for a consumer, the real value of money for a consumer also changes. When there is an increase, it increases the money balance of a consumer which helps him to consume more than what he was able to consume in the previous period and vice versa when the real asset value decreases. Therefore, there will be a shift in the consumption function and option 'a' is incorrect.

Option (b):

The interest rate determines the consumption function of an individual. When the rate of interest is higher, consumers will consume less and save more and vice versa. Thus, the changes in the interest rate of the economy shift the consumption function. Hence, option 'b' is incorrect.

Option (c):

The expectations of the price change are an important factor that leads to the shift in the consumption function. The decrease in the price level increases the real balances of the consumer, whereas the increases in the price level decreases the real balances that cause the shift in the consumption function. Hence, option 'c' is also incorrect.

Option (e):

The taxation determines the income of consumers. When the tax rate is decreased, it increases the income of consumers and vice versa when the tax is increased. Hence, the changes in the taxation policies lead to the shift in the consumption function and option 'e' is incorrect.

Economics Concept Introduction

Consumption function:  The consumption function is an economic formula that represents the functional relationship between the total consumption and the gross national income of the economy.