Question

"Under a study, examining the spending habits of a hypothetical economy, it was observed that even households with zero income managed to consume basic necessities. As the income of people increased, their consumption also increased, but not as rapidly as income."
Based on the given text and common understanding, answer the following questions: (i) Identify and elaborate the type of consumption indicated in the first para of the above text. (ii) Explain, the reason behind the positive slope of Aggregate Demand Curve.

Hint:

Autonomous consumption is the consumption that occurs even when income is zero, often funded through borrowing or savings. The positive slope of the AD curve reflects the increase in total demand as income rises.

Answer 1

Step 1: Identifying the Consumption Type.
The phenomenon where consumption exists at zero income is called Autonomous Consumption (c0). It represents the minimum expenditure required to sustain life (food, shelter, etc.). Households fund this through past savings (dissaving) or by borrowing.

Step 2: Explaining the Positive Slope of the AD Curve.
In the context of the income-expenditure model, the Aggregate Demand (AD) curve slopes upward (positively) because of the induced nature of consumption. As national income increases, households have more disposable income. According to the psychological law of consumption, higher income leads to higher spending. Since consumption is a major component of AD (AD = C + I + G + NX), the total demand rises as income levels grow.