Question

In: Economics

Consider a goods market in the following situation. (1) Aggregate demand: Z=C+I+G (2) Aggregate supply: Y=Z...

Consider a goods market in the following situation.
(1) Aggregate demand: Z=C+I+G
(2) Aggregate supply: Y=Z
(3) C(Consumption)
= c0 + c1√YY − TT,
if
YY ≥ TT
;
C = c0 > 0, if YY < TT
(4) (Exogenously given) I=investment, G=government spending, T=government tax
revenue
(a) Represent
SS
(saving) as a function of
Y
(the aggregate income).
(b) Find
Y∗
(an equilibrium aggregate product or income). What additional condition or
assumptions do we need to get a unique solution?
(c) Suppose that
c1
increases. Assess its impact on
Y∗.

Solutions

Expert Solution

a)

savimg is part of incomewhich is not spent on current income.

We can say that ,

S = f (Y)

there are two features of saving are:

1) saving can be negative at zero or low level of income

2) As income increases, saving also increases but more than the increase in income.

we called saving as

S = Y - C

= Y - [ + bY] where [ = bY]

= Y - - bY

S = - + [ 1 - b ] Y

Where C is the autonomous consumption and -C represents dissaving. At zero level of income, amount of autonomous consumption = amount of dissaving . And b = MPS ( marginal propensity to consume) calculated as

(1 - b ) = mpc

the relation between income and saving is, when the income increases , saving is also increases but less than increase in income. it means as income increases, proportion of income saved increases.

At lower level of income, saving is negative. In the initial stage when there is very low level of income, consumption expenditure is more than income leading to negative saving.

b)

Y is identified as GDP in equation form that include consumption (C) , investment (i) , Government spending (G) and net export (X - M).

  • Y = C + I + G + ( X - M )
  • C ( consumption ) is largest GDP component in the economy,
  • investment ( I) include for insatnce business investment in equipment , but does not include exchanges of exixting assests . spending by hosehold is also considered as investment.
  • G ( government spending ) is the sum of government expenditure on the final goods and services. It include salaries of private and public servents, puchase of weapons for the military and any investment expenditure by a government.
  • X ( expots) represents gross export. GDP capture the amount a country produces
  • M (imports) represents gross imports. imports are subtracted since imported goods will be included in terms of G , I OR C and must be deducted to avoid foreign supply.

c)

consumption is being a part of income , C = f(y)

when income is increases , consumption also increses but by a lesser amount i.e, additional consumption is less than additional income . this may be represent by b ( marginal propensity to consume).

consumption function in a straight line represent by a equation.

C = C + bY ( 0 < b < 1 ) .


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