Question

Question:

Using consumption function explain the effect of strong exchange rate on investment within the UK economy?

Answer 1

consumption function is the sum of autonomous consumption and induced consumption

C= + b.Y

C= CONSUMPTION FUNCTION = AUTONOMOUD CONSUMPTION b= Marginal PROPENSITY TO CONSUME Y= INCOME LEVEL

As the currency gets stronger, the value of investments in the economy and the return from domestic investments tend to increase. this increase in investments and returns increase the income of the people . the increase in investment leads to an increase in employment opportunities and opening of new businesses in the economy. this increase in employment opportunities also raise the living standards, purchasing power and income of the employees. also strong currency results in suppression of prices to tackle which, interest rates are decreased so people can get loans for a cheaper rate of interest which increases their consumption. also the prices of goods become cheaper so utility and autonomous consumption of people tend to rise to a higher level.

all thease factors lead to a rise in autonomus consumption () , MARGINAL PROPENSITY TO CONSUME (b) and INCOME LEVELS OF THE ECONOMY (Y).

THUS, the consumption function will increase and show a rise in consumption and thus in aggregate demand of the UK economy.

THE only drawback of a strong currecny is the fall in exports de to export becoming costlier for other countries with weaker currencies which will negate the rise in consumption to some extent.