Question

In: Economics

Consider the following data ( in millions of dollars): Year Real DI Real C 0 1900...

Consider the following data ( in millions of dollars): Year Real DI Real C 0 1900 1839 1 2000 1935 2 1700 1647

For now, assume that no other variable ( besides disposable income) that could affect real consumption has changed between Year 0, Year 1, and Year 2. a.) Draw the general shape of the consumption function. b.) Solve for the marginal propensity to consume ( show your work). c.) What is the slope of this consumption function ( give a numerical answer)?

Solutions

Expert Solution

(a) General form of consumption function: C = C0 + MPC*YD

Where C0 is autonomous consumption (i.e., consumption level at zero level of disposable income). It is reprsented by a intercept of consumptioni function

MPC is marginal propensity to consume. It is the slope of consumption function. .

Genreally, the consumption curve is upward sloping linear line.

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(b)

Year Real DI Real C
0 1900 1839
1 2000 1935
2 1700 1647

Marginal propensity to consume measures the change in consumption due to change in disposable income.

MPC = ΔC / ΔDI

Note: DI is disposable income

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Between year 0 and 1, Real DI increases from 1900 to 2000, as a result Real C increases from 1839 to 1935

=> ΔDI = 2000 -1900 =100

=> ΔC = 1935 - 1839 = 96

---------------

MPC = ΔC / ΔDI

=> MPC = 96 /100

=> MPC = 0.96

The marginal propensity to consume is 0.96

Note: You will get the same MPC, if MPC is calculated between year 1 and 2.

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(c) MPC is the slope of consumption function.

Hence, the slope of consumption function is 0.96


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