Question

1. Disposable National income 2000 = $4.5 billion                    Consumption = $4.0 billion

Disposable National income 2007 = $5.5 billion                    Consumption = 4.8 billion

1. Given the data above, what is this country’s marginal propensity to consume (MPC)?

2. What is the country’s marginal propensity to save (MPS)?

2. Fred works as an accountant and earns a paycheck of $1000 every week, but $300 are taken out in taxes. Fred’s consumption spending is normally $500.

1. What is Fred’s personal disposable income?

Now assume the Federal Government gives tax cuts to many individuals, including Fred, so as a result, his taxes are only $150 this week. As a result, he increases his consumption to $600.

2. What is Fred’s MPC?

3. What is Fred’s MPS?

4. Who do you think has a higher MPC, the rich or the lower-income? Why?

5. If the government is looking to use monetary or fiscal policy to quickly boost the economy out of a recession, does your answer above give any advice as to whom they should target their policies? In other words, should it target its stimulus at the rich or the poor? Or does it make a difference?

3. You don’t have to share your income if you don’t want to, but write down (or keep in mind) your disposable personal income per month and your estimated consumption for an average month at this point in your life.   

1. Assume your income increases by $500 next month, and you know this is a one-time bonus. Your income will decrease again to its old level next month. How much would you spend? How much would you save?

Use these to estimate your MPC and MPS.

2. Assume your income increases by $500 next month, and you know this is a permanent raise. How much would your spending, on average, increase in the coming months? How much would your saving, on average increase, in the coming months?

Use these to estimate your MPC and MPS.

3. Compare your MPC and MPS in the two scenarios above (temporary increase vs. permanent increase) with your teammates’. Do your answers tend to favor the current income hypothesis or the permanent income hypothesis?

Answer 1

1.

Disposable National income 2000 = $4.5 billion                    Consumption = $4.0 billion

Disposable National income 2007 = $5.5 billion                    Consumption = 4.8 billion

a.

MPC= Change in Consumption / Change in disposable income

MPC= (4.8-4)/(5.5-4.5)= 0.8/1= 0.8

a.

Relatiosnhip between MPC and MPS:

MPS+MPC = 1

MPS+0.8=1

MPS= 1-0.8= 0.2

Fred works as an accountant and earns a paycheck of $1000 every week, but $300 are taken out in taxes. Fred’s consumption spending is normally $500.

a.

Personal disposable income is the amount which remain with consumer after paying tax.

Fres's disposable income= Income-tax= $1000-$300= $700

Now assume the Federal Government gives tax cuts to many individuals, including Fred, so as a result, his taxes are only $150 this week. As a result, he increases his consumption to $600.

a.

Initially when tax was $300, disposable income= $700 and consumption= $500

Now as tax=150, disposable income= $1000-$150= $850 and consumption= $600

Fred's MPC= (600-500)/(850-700)= 100/150= 10/15= 2/3

a.

Fred's MPS= 1-MPC= 1-2/3= 1/3

a.

Generally when income level is low a person need to spend a significant part of its increased income on consumption. At lower level of income person's savings are negligible. But as the income increases and reaches a particular level where person is already fulfilling its basic needs and some desire in that situation as the income increases the person will spend less of it and save more.

So poor people will have higher MPC and rich people have lower MPC.

a.

Consumption is considered as the injection in the economy and savings are leakages. Generally an increase in autonomous expenditure will cause income to increase by many folds. This is called as multiplier.

Multiplier= 1/1-MPC= Change in income / Change in Government expenditure

Here as value of MPC is higher the value of multiplier is also higher which means that change in income due change in government will be higher. While if value of MPC is lower the value of multiplier is also lower which means that change in income due change in government will be lower. So if government want to use monetary policy or fiscal policy to boost economy out of recession then it must focus on group which has higher MPC that is Poor section of the society.