Let the consumption function be defined by C = 0.85 + 0.8YDP with permanent disposable income specified according to YDP = 0.75YD + 0.25YD-1). Which of the following is true?
A) The long-run MPC = 0.85 while the short-run MPC = 0.6.
B) The long-run MPC = 0.8 while the short-run MPC = 0.75.
C) The long-run MPC = 0.8 while the short-run MPC = 0.6.
D) The long-run MPC = 0.8 while the short-run MPC lies somewhere between 0.25 and 0.75.
E) Both the long-run MPC and the short-run MPC equal 0.8.

Question

Quizplus · Accepted Answer

The long-run marginal propensity to consume (MPC) is determined directly from the consumption function C = 0.85 + 0.8YDP, which is 0.8. The short-run MPC can be calculated by considering the effect of a change in current disposable income (YD) on consumption, taking into account the formula for YDP = 0.75YD + 0.25YD-1. A change in YD affects YDP by 0.75 in the short run, so the short-run MPC = 0.8 * 0.75 = 0.6.

Let the Consumption Function Be Defined by C = 0