Question

Which one of the following statements is CORRECT in the context of the Keynesian Absolute Income Hypothesis?

• A. The marginal propensity to consume increases as the income increases.
• B. The average propensity to consume increases as the income increases.
• C. The average propensity to save decreases as the income increases.
• D. The average propensity to consume approaches the marginal propensity to consume as the income increases.

Hint:

In Keynes’ consumption function: \[ APC=\frac{a}{Y}+MPC \] As income rises, \(\frac{a}{Y}\) becomes very small, so APC approaches MPC.

Answer 1

The Correct Option is D

Step 1: Write the Keynesian consumption line.
Consumption depends on current income through
\[ C=a+bY \]
where $a$ is autonomous consumption and $b$ is the marginal propensity to consume.

Step 2: Note the two ratios.
The marginal propensity is $MPC=b$, a fixed slope. The average propensity is
\[ APC=\frac{C}{Y}=\frac{a}{Y}+b \]

Step 3: See what happens as income grows.
As $Y$ rises, the term $\dfrac{a}{Y}$ shrinks toward zero, so $APC$ falls and creeps down toward $b$.

Step 4: Read the options.
$MPC$ stays constant, and $APC$ does not rise, so those options are wrong. What is true is that $APC$ moves closer to $MPC$ as income grows.
\[ \boxed{APC\to MPC \text{ as income rises}} \]