question_answer

Distinguish between marginal propensity to consume and average propensity to consume. Give a numerical example.

Or

Explain the role of taxation in reducing excess demand.

Answer:

Marginal Propensity to Consume	Average Propensity to Consume
The ratio of change in consumption (\[\Delta C\]) due to change in income (\[\Delta Y\]) is called marginal propensity to consumption.	The ratio of total consumption expenditure to total income is called average propensity to consume.
\[MPC=\Delta C/\Delta Y\]	\[APC=C/Y\]
MPC is always greater than zero but less than 1.	APC can be greater or less than 1 but can never be zero because at zero income, survival needs minimum consumption.
MPC falls more rapidly with rise in income.	APC falls as income rises.
Eg - if income of a country increases from Rs. 5000 crores to Rs. 5500 crores, consumption expenditure goes up from Rs. 4000 crores to Rs. 4300 crores, then: \[MPC=\Delta C/\Delta Y=300/500=3/5=0.6\text{ }or\text{ }60\text{ }paise.\]	Eg - Aggregate income of the economy = Rs. 5000 crores and aggregate consumption is Rs. 4500 crores, then: \[APC=C/Y=4500/5000=0.90\text{ }or\text{ }90%.\]
Or
Role of taxation to reduce excess demand:
Important part of fiscal policy is revenue policy which is expressed in terms of taxes. During inflation, government should raise rates of all taxes especially on rich people because taxation withdraws purchasing power from the tax payers and to that extent reduces effective demand. The non?discretionary elements refer to in?built stabilizers of income which operate automatically in reducing excess demand like progressive income tax, subsidies, old ?age pension and others such as transfer payments.