Question

Due to political turbulences in Hong-Kong and the extensive protests consumers’ confidence has deteriorated in the island. The marginal propensity to consume has declined from 0.8 to 0.6. a. Use the consumption model to asses the effects of the decline in MPC on overall consumption. Use the model and the graphs. Explain.

b. How it will affect overall aggregate demand? Use the AD model with positive slope (model, graph and explanation)

Answer 1

QUESTION-FIRST

• MPC implies Marginal propensity to consume.it is ratio which represent how much a person spend out of his changed iincome.
• when the multiplier would decline then the effect of multiplier would also decline and we can see the two edge sword effect by the following diaram.

the above diagram is derived from the multiplier concept which is concerned with MPC and it shows when a proportion of investment is reduced due to declining demand then the decrease in income's proportion is more than the change in invesment.this problem would lead to recession situation.

IMPACT OF DECLINE IN MPC-

• When MPC declines then the size of multiplier decreases it means the increased investment is quickly observed by the economy and it leads to recession phase.
• producer sector would cut down the level of production due to declining demand
• the unemployement would increase in the economy.

QUESTION-SECOND

• people would be intended to save more and more money and spend a little portion of their respective incomes.therefore due to lack of demand producers would get discouraged and won't produce as per their potenital level of production.

when the MPC would decline then a large portion of income would be saved and saving would be greater than consumption.we can understand this concept with the following graph.

in the graph as we can see after a certain point the level of saving surpasses the consumption level.