If the consumption function is given by C = 150 + 0.85(Y - T) and T increases by 1 unit, then savings:
A)decreases by 0.85 unit.
B)decreases by 0.15 unit.
C)increases by 0.15 unit.
D)increases by 0.85 unit.

Question

Quizplus · Accepted Answer

As T increases by 1 unit, Y - T decreases by 1 unit (assuming Y is constant). Substituting this into the consumption function, we get: C = 150 + 0.85(Y - (T+1)), which simplifies to C = 150 + 0.85(Y - T) - 0.85. Since savings is simply income (Y) minus consumption (C), an increase in T will lead to a decrease in consumption (C), which in turn will lead to an increase in savings. The decrease in C will be equal to 0.85 times the decrease in Y - T, which is 0.85 times 1 unit, or 0.85 units. Therefore, savings will increase by 0.85 units, which is the opposite of the correct answer. The correct answer is B, which states that savings will decrease by 0.15 unit.

If the Consumption Function Is Given by C = 150