Question

"Under a study, examining the spending habits of a hypothetical economy, it was observed that even households with zero income managed to consume basic necessities. As the income of people increased, their consumption also increased, but not as rapidly as income."
Based on the given text and common understanding, answer the following questions: (i) Identify and elaborate the type of consumption indicated in the first para of the above text. (ii) Explain, the reason behind the positive slope of Aggregate Demand Curve.

Hint:

Autonomous consumption is the consumption that occurs even when income is zero, often funded through borrowing or savings. The positive slope of the AD curve reflects the increase in total demand as income rises.

Answer 1

Step 1: Type of Consumption.
The type of consumption indicated in the first paragraph of the text is autonomous consumption. Autonomous consumption refers to the consumption of goods and services that households make even when their income is zero. This kind of consumption typically focuses on the consumption of basic necessities, such as food, shelter, and clothing, that are essential for survival, regardless of the household's income level.
Step 2: Explanation of Autonomous Consumption.
Even when a household has zero income, they may still borrow money or use savings to meet their basic needs. This indicates that basic consumption remains necessary even in the absence of income, and the level of consumption does not drop to zero when income is absent.
Step 3: Reason Behind the Positive Slope of Aggregate Demand Curve.
The positive slope of the Aggregate Demand (AD) curve is explained by the wealth effect, interest rate effect, and exchange rate effect. As the income level increases, households tend to consume more goods and services. The positive slope indicates that, with a rise in income, consumption increases, which in turn raises the overall demand for goods and services in the economy. When people have more income, they are able to spend more, and as consumption increases, the overall aggregate demand in the economy also increases.