The compilation of these Income Determination Notes makes students exam preparation simpler and organised.
Movement Along a Curve versus Shift of a Curve
Income comprises consumption, savings, and investment components. But what happens to these variables when income changes? And, what happens to them when at a given level of income, other variables change? The answer lies in the difference between a movement along a curve and a shift of a curve. Read this simple lesson with a diagrammatic explanation to understand the distinction.
National Income and Movement of Curves
In the lesson on Income determination, we have learned how income is determined in an economy. We have also understood the concept of ex-ante and ex-post. But what happens when a country’s income changes? Does the national income of India remain constant? No, certainly.
The implication of this change in Macroeconomics is reflected through two kinds of movements of curves: movement along a curve and shift of a curve. It is best to understand the difference between them so as not to confuse them. This lesson will make it simple to understand the difference.
Movement along a Curve
We know that as income increases, consumption increases due to a positive marginal propensity to consume (MPC). This explains the relationship between consumption and income, i.e. C = f(Y)
The consumption function slopes upward because of this positive income-consumption relation. The more income you have in hand, the more you can spend to consume goods and services, right? Now, if income increases, from Y0 to Y1, consumption increases as we can see, from C0 to C1.
Let us now look at savings. As income increases, you have more income in hand that you can choose to save for future use. Thus, the more the income more will be the savings. This explains a positive relationship between income and savings as well, due to a positive marginal propensity to save (MPS). This is the savings function, as under S = f(Y)
Thus, the savings function slopes upward as well. Now, as income increases from Y0 to Y1, from the positively sloped savings function, we can see that savings must increases from S0 to S1.
The above two cases are shown in the first two panels of the figure below. Here, since the consumption and savings increase as functions of income on which they are dependent, we call it moves along a curve.
No discussion of income, consumption, and savings can be complete without considering the investment, right? In our discussion, we consider the investment as autonomous or determined from outside and to be a given value. Hence, as income increases, investment remains the same and does not change. The horizontal investment curve shows that it is given and constant.
The shift of a Curve
Think about this. Your consumption depends not only on your income but also on other factors, like your tastes and preferences, your wealth, etc. For instance, you might experience a shift in taste in favour of jute bags from polythene bags. Or, when your wealth increases due to accumulated savings, you may feel richer to spend more on consumption. Such cases represent factors other than income that cause consumption to increase. This leads to a shift of the consumption curve from C to C’. An increase in consumption is depicted by an ‘upward’ shift of the consumption curve.
We know that consumption and savings functions are analogous to each other and when consumption must increase, less income is available to be saved. Hence, the savings function ‘shifts downward’. Again, here other factors rather than income have affected savings level and caused the shift.
If you are to look at investment, the investment function may shift due to other factors like interest rate. When the interest rate falls, the cost of investing falls and it is more profitable to invest. Thus, the investment function shifts upward.
To sum up, movement along a curve is always associated with a change in the independent variable. In the case of the consumption and savings functions, income is the independent variable. On the other hand, a shift of a curve is associated with changes in other variables affecting the dependent variable other than the independent variable (say, wealth in case of consumption) and is caused due to changes in other factors affecting consumption/savings/investment at any given level of income.
What is the ratio of Marginal Propensity to Consume?
The ratio between the change in consumption expenditure and the change in Income is called Marginal Propensity to Consume (MPC).
MPC = ΔC/ΔY