(a) “Consumption and saving curves complement each other.” Do you agree with the statement ? Explain with valid reasons. (b) “Taxes help to curb deflationary situation in the economy.” Comment.

Question

Accepted Answer

(a) Yes, consumption and saving curves complement each other. They are mirror images because:
- Income is either consumed or saved: Y = C + S
- When consumption increases, saving decreases proportionally, and vice versa.
- The sum of MPC and MPS equals 1: MPC + MPS = 1
- The consumption function (C = c̄ + bY) and saving function (S = -c̄ + (1-b)Y) are derived from the same income.
- Graphically, the vertical distance between the 45° line and the consumption function equals the saving function.
- At the break-even point where C = Y, saving is zero.
- Below break-even, consumption exceeds income (dissaving), and above it, saving is positive.

(b) Taxes help to curb deflationary situations because:
- During deflation, aggregate demand is insufficient, leading to unemployment and low output.
- Tax reduction increases disposable income (Yd = Y - T).
- Higher disposable income leads to higher consumption expenditure.
- Increased consumption raises aggregate demand.
- Higher AD stimulates production, employment, and income.
- The multiplier effect amplifies the initial increase in consumption.
- Thus, tax cuts act as an automatic stabilizer during deflationary periods.