Question

Chapter 12 and Appendix B are an introduction to the Keynesian Theory authored by John Maynard Keynes (note, his name is pronounced "Canes" like the thing you need to walk if you are old!). He revolutionized the way we view the overall economy as well as the way we study economics. His theory changed the entire approach. Prior to Keynes, the focus was on the study of “microeconomics” and specifically the supply side of the market. Because of him we now look at Macroeconomics, and more precisely on consumption and income. He introduced the concepts of the Marginal Propensity to Consume (MPC) and the Marginal Propensity to Save (MPS), which led to the Consumption Function (C = a + bY). This brings us to some interesting observations…Why do rich people have a higher marginal propensity to save than poor people? In what ways can households spend more than they have in income? (Note: Spending in excess of current income is called dissaving.)  Where do they get the money to finance their extra consumption? Can everyone dissave at the same time? Do you think there is a relationship between "dissaving" and the most recent economic crisis (2007 - 2009)? What is the relationship?

Answer 1

Soln.:

As per keyens consumption function is C = A +BY. where A is the autonomous consumption which is uneffected with the level of income where as BY is that portion of consumption that changes as income of a person rises. therefore cumsuption portion A cannot be 'Zero' as it is the neccesity.But in modern society consuption pattern of people changes a lot A part of autonomous consumption rises a lot and due to market developments consumerism spread alot, In so competitive market companies advertise their product so well and financial institutions took advantage of this competitive market by providing loans for this increased huge consumption pattern, for which bank started lending mortage loan from where the connection established between the consumption pattern and crisis of 2007 - 2009.

Dissaving can be understood as Loan taken by someone to fulfill one's autonomaous consumtion needs.

while providing mortgage loan there is a systematic risk which is bear by the bank and this systematic risk can be thought of as huge failure of the financial institutions. by which financial market got feezed, All this started in 2006 beginning when huge no. of mortgage loans were designed for subset the market with a balooning interest payment, this loans are famously known as subprime mortgate, main purpose of this subprime mortgage was to re finance the existing mortgate loan to avoid the jump in the mortgate rate, but with a expectation of appriciation in the housing sector. Unfortunatly housing market collapse and it was preassumed now that subprime sector will have future defaults, results in bankruptcy declared by the owhnit mortgate solutions followed by second largest subprime lender "new centurey financial" which became the main reason of the crisis of 2007-2009