1. Assume that you have won $2 million in the California lottery. Explain exactl

Question

1. Assume that you have won $2 million in the California lottery. Explain exactly what you would do with this windfall within the next year.

Using your response to the above example:

2. What would be your MPC (marginal propensity to consume) and your MPS (marginal propensity to save)? Refer to lecture notes explaining each.

3. Instead of an extra $2 million assume you get an extra $2,000. What would be your MPC and MPS in this case?

4. Explain why there was or was not a change from ‘a’ to ‘b’ above.

Explanation / Answer

1. Out of $2 million won in the California Lottery, $1 million is used for personal consumption , ie.for purchasing a car and the balance $1 million is saved.

2. Marginal propensity to consume is defined as the change in consumption with the change in consumption.

Thus, Marginal Propensity to consume = 1,000,000 / 2000000

=0.5

Marginal Propensity to save = 1000000 / 2000000

= 0.5

3. Instead of an extra $2 million ,if I get an extra $2000, I would spend $1500 for consumption and $500 for savings.

Marginal propensity to consume = 1500 / 2000

= .75

Marginal propensity to save = 500 / 2000

= .25

4. There was a change in MPC and MPS from a to b as in the first case the increase in income is high , so large amount is used for consumption and for savings. But when the rise in income is less, consumption is and savings get affected negatively. Larger portion is spent on consumption and less for savings.

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