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INDIVIDUAL PORTRAITS: The Consumption Function, APC and MPC: Let us examine these three concepts by looking...

INDIVIDUAL PORTRAITS: The Consumption Function, APC and MPC: Let us examine these three concepts by looking at ‘real-life’ examples of American households: EXAMPLE #1: “Tom Green has lost his job, and, for a few months, his family is spending more money that they are earning in net income, perhaps ‘living off of past savings’ or diving more deeply into credit card debt”. We will examine how this person’s net income does not drop to zero for the year, or even in half. There are some ‘safety net’ programs that he and his family may qualify for, including Medicaid (in our state it is called mediCAL), food stamps, housing programs, and unemployment insurance. This ‘portrait’ of Tom Green carries with it extra significance, as our country has been hit by a wave of layoffs never seen in its history: in just four weeks, in April, 2020, 22 million people filed claims for unemployment insurance, overwhelming the benefits system in our country. Tens of millions more workers lost their jobs and DID NOT file claims with our government. Millions more workers have lost their jobs since that time. Our government has responded by greatly expanding unemployment insurance benefits as part of a $2.2 trillion stimulus program passed and implemented by our federal government to address the human misery created by the pandemic and the recession. Tens of millions of workers have lost their jobs in America in 2020. This expansion of benefits, which includes covering workers who had not been covered previously, including many ‘gig economy’ workers and many self-employed workers, may be a permanent change in the way benefits are delivered to workers who have lost their jobs. This may be a good thing. You have to form your own opinion on this matter. The extra $600 per week that SOME laid-off workers may receive--- IN ADDITION TO OTHER BENEFITS a laid-off worker may receive ---may last for only four months—or they may be extended. Unemployment benefits vary from state to state, and usually last for about 26 weeks. They were extended to 99 weeks for some workers in some states during the 2008-2009 recession. This may happen again if the recession of 2020 drags on for several months and even years. Let’s say the Tom Green family earned $61,000 in gross income in 2019 (this will drop for 2020), paid $21,000 in taxes, earned $40,000 n net income in 2019, spent $38,500 and saved $1,500 in 2019. He loses his job on April 1, 2020, and let’s say he finds another job on July 1, 2020. His family will suffer a drop in net income from 2019 to 2020. Even before the pandemic, this would happen to at least 4 million families in this country each month. Before the pandemic, let’s say that in a normal month, 4 million jobs in the U.S. would be ‘lost’, or ‘destroyed’, and perhaps 4.2 million jobs would be created, for a NET job GAIN of +200,000 jobs in a typical month. Obviously, these numbers would vary from month to month. Thus, the Tom Green household will see their net income come in at $3,333 per month for the first three months of the year, that is, $10,000 for the period Jan 1 to March 31, then drop to $0, in theory, for the three months of April, May and June. He secures another job on July 1, 2020, which pays him a net income of $3,000 per month. Thus, he suffers a ‘pay cut’ in a sense. By July 1, he is just happy to find another job! His income for the six months from July 1 to Dec. 31 is ($3,000 per month) x (six months) = $18,000. In theory, this would put him in a situation where his family earned $40,000 in net income in 2019 and only $28,000 in net income in 2020. He will ‘move down’ the Consumption function, if you wanted to graph it that way. What may be lost in all of this drama is that, at least before the pandemic, Mr. Green may have gone from “Job A” which HAD a health insurance program to “Job B” which DOES NOT have a health insurance program at work. The U.S. is the only ‘major industrialized’ nation where if a worker loses his job, he often loses his health insurance as well. Obamacare was passed by the House and the Senate in 2010---we are celebrating the 10th anniversary--- owing to TENS of millions of Tom Greens losing their ‘old’ jobs, getting new jobs, but losing their health insurance plans in the process. In America, many new jobs are created by small businesses (until March 2020) and often these employers do not offer health insurance plans at work for their workers. During those three months between jobs, and after July 1, 2020, Tom Green must make the decision as to whether to BUY health insurance from a provider. If he lives in our state, Covered California will help him pay the monthly premiums for health insurance by paying for some, or even all, of his monthly payments. This may not be true in many states in the South and the Midwest. It is a shame that this does in fact vary from state to state, as health care is obviously a national issue and a national goal. During the three months between jobs, Green’s income may not drop to $0 for many reasons. REASON #1: Green and his family MAY qualify for unemployment insurance benefits. Now, we discussed the incredible expansion of benefits for this incredible year. Yet, in years before 2020, and perhaps, in years after 2020, Green must get past FOUR RED LIGHTS--- or HURDLES--- in order to get that $330 per week in weekly unemployment benefits (this could be higher or lower---- $330 per week is the amount my friend collected a few years ago)--- please remember that the extra $600 per week offered to SOME workers for four months is unusual, and not the historical average, and possibly a “one-shot” deal. In order to collect benefits, in normal times, Tom Green must overcome four hurdles. HURDLE # 1. Mr. Green must work at a certain job—a job that is part of the unemployment insurance (U ins.) system. Some jobs are, some are not. Before March 2020, less that half of all workers could collect U ins. benefits when their jobs ended---I recall being very surprised when I learned this. Now, maybe that ratio has changed forever. EVEN NOW, most farmworkers DO not and CAN not collect these benefits if and when their jobs end. Our governor has allocated some funds for these workers as a SPECIAL program. That simply proves my point. Now, maybe some of these workers are ‘undocumented’. One may argue that they still deserve benefits if and when their jobs are terminated. You have to form your own opinion on this matter. Our system of food production and distribution COULD NOT OPERATE without these workers. HURDLE #2: He must work there for a certain number of hours each week, and for a certain amount of time. I have had SO many students tell me that they were let go JUST before they were to ‘vest’ and qualify for benefits---some employers can be real jerks. Sometimes an employer will keep a worker under 32 hours per week --- or less or more---just so that they do not qualify for benefits—medical as well. HURDLE #3: Green’s employment must end for certain reasons--- and not other reasons. It is complicated, but generally, if Green’s job ends owing to a downturn in business activity, he may qualify. If he loses his job because he is constantly late, takes two hours for lunch, and comes in every Friday drunk, or stoned, or BOTH…. then he will not qualify for benefits. If there is some dispute over this issue, then Green may ‘fight’ his employer---ex-employer—over the issue in front of some arbitrator assigned to resolve the dispute. The employer may fight his claim (in normal times), as the employer does not want HER premiums to rise—this may increase her costs of doing business. HURDLE #4: GREEN MUST STEP FORWARD and make a claim! Many workers clear the first three hurdles but not the fourth! 2020 is a tragic example of how DIFFICULT it can be for a worker to GET THROUGH to the EDD---the agency that processes claims. The worker in this case is disoriented, depressed, lonely--- he just lost his job. It may take SEVERAL ATTEMPTS to get through—by phone, online, or in person. Green must try over and over in order to succeed. If all four hurdles are cleared, Green may receive this payment of $330 per week or about $1,400 per month---for those three months between jobs. If so, his net income does not drop from $40,000 in 2019 to $28,000 in 2020, it drops from $40,000 to $32,400---still a huge drop. However, two more elements come into play: Tom Green may be part of a TWO INCOME household. If he is, then his job loss will cause a drop in the family’s income, to be sure, but the drop will be of a lesser magnitude. It is so easy to ‘see’ a household earning $61,000 per year and just assume that this involves one person earning about $30 an hour at work. Often, the household consists of TWO people, each earning $15 an hour at work. If this is the case with the Tom green household, then the drop in income is not as severe. Even if the other wage earner is bringing in $1,000 per month, the drop in income is ‘cushioned’, so to speak. Finally, let’s say that the Green household will see a drop in gross income of $4,000 for the year. His family will earn $57,000 in 2020, as compared to $61,000 in 2019, for example. IS HIS FAMILY REALLY ‘OUT’ THAT $4,000? Not really: half of that ‘missing’ $4,000 WOULD HAVE BEEN TAXED by the five major taxes, FIT, FICA, SIT, sales and special. His family earns $57,000 in gross income but pays only (roughly) $19,000 in combined taxes, to net about $38,000, instead of $40,000. I am telling you, when Tom Green settles down to prepare his 2020 taxes in April 2021, he will be convinced that the numbers are incorrect! “How could my family have ‘lost’ ONLY $4,000 from 2019 to 2020???” “There must be some mistake!” Now, even though his family’s net income dropped by $2,000 for the year, his family very well may not have cut back on their SPENDING by exactly that amount. This depends upon the family. There is a good chance that his family’s APC has risen above .96---he and his family could easily be spending more than their net income for the next several months—they have ‘suffered’ a 10% drop in monthly income---but will they cut back on their SPENDING by 10%? Probably not. LONG TERM, the most salient fact here is that he and his family STARTED the year with a health insurance plan at work covered by Job A, and he ENDED it WITHOUT one in Job B. HE MUST STEP FORWARD AND ACT to obtain a health insurance policy---we try to ‘reach out’ to Mr. Green in our state AND CONVINCE HIM TO SIGN UP FOR HEALTH INSURANCE THROUGH COVERED CALIFORNIA. He will be surprised at how much help he can get from our state government! PORTRAIT #2: “The widow Smith can ‘barely make ends meet’ by living off of the interest generated by her wealth, yet she NEVER DARES to ‘spend down’ the wealth itself. The widow Smith may be used to represent the tens of millions of senior citizens living in our country, over 70 million of whom earn a social security benefit payment averaging about $1,500 per month. Let’s start with a model wherein she does not received these benefits---let’s say, for some reason, she is not ‘in the system’. In theory, let’s say she has $500,000 in wealth, deposited in at least two bank accounts, earning 3% interest (these are long-term certificates of deposit that are ‘coming due’ soon. She will NOT get a 3% interest rate when she turns the money over). In theory, this $15,000 in net income would be BARELY enough for her to survive—we may think she would earn $15,000 per year in net income and spend $15,000 per year in consumption, for an APC measure of 1.00----after all, it is only $1,250 per month for her to live on. My BIGGEST question about her life is: what is her HOUSING situation? Let’s say she lives in a house that is ‘paid off’--- free and clear—no mortgage, and no monthly rent payments. She visits a ‘trusts and estates’ attorney to draw up her living trust, as she knows she will die soon – pretty heavy stuff. The widow informs her attorney about her wealth, her three children, how she does not want any of her wealth to transfer to the third child, who is a disappointment---like a said, heavy stuff. The attorney grows tired, as it is late in the day, and blurts out to the widow: “You know, widow Smith, you should take a cruise around the world (this is before Feb., 2020)--- it will cost about $20,000” --- and the widow Smith is SHOCKED! “Are you OUT OF YOUR MIND?? I would make $15,000 in net income and spend $35,000 in spending for the year! My wealth would drop, by $20,000, thus my YEARLY INTEREST INCOME WOULD BE LOWER FOREVER!!”… and the attorney says something that she will regret: “Listen up, old lady--- you can spend $20,000 a year more than you earn for the rest of your life---my actuarial tables here tell me you have 14 more years to live---you will die long before you run out of money!”---and, while this may be true, this is NOT what the widow, or any old person EVER wants to hear. In fact, she will NOT run her life so that her life savings draws down… down… down… $500K….. $480K… $460K… $440K…. damn! I BETTER DIE SOON ! BEFORE I RUN OUT OF SAVINGS!!! No--- the widow Smith wants to see her wealth RISE over time! So she spends only $13,000 per year in consumption---spending--- under 90% of her net income! In fact, her APC comes in at $13,000 divided by $15,000 = .867! The widow saves over 13% of her income! She is a super saver! And this is quite common among older people. She could be sitting on $1.5 million in savings, and EVEN I WOULD TELL HER she could ‘spend it down’—and she still will not do it! Now, most likely, the widow will receive social security benefits, but that may be less that $1500 per month—remember, that number is the median—half of all Americans receive less than that amount each month. She may receive, say, $900 a month in SS benefits, and another $350 per month from a small pension, for a total of $1250 per month. The widow Smith is ABOVE THE POVERTY LINE! A household of one falls below the poverty line if that person earns below $11,000 (roughly) in income! Incredible! The poverty line is a very low line! PORTRAIT #3: The Schultz family is SO RICH… that they used the ‘extra’ money thet ‘earned’ in 2019, as compared to 2018, to ‘invest’ in a limited partnership for oil drilling”. Let’s put the Schultz family at a gross income of $160,000 in 2018, minus $60,000 in taxes, for a net income in 2018 of $100,000. Life is good at $100,000: we see TWO nice cars in the driveway, a nice house, great food, medical care—all a family needs and most of what it wants. They spend $80,000 in 2018, and save $20,000 in 2018. Their APC is .80 in 2018. They enjoy a rise in net income of +$10,000 in 2019, as the family may be headed by a worker who is highly paid, perhaps a Vice President, who earns a $10,000 ‘end of the year’ bonus. Or she is a partner in a law firm or accounting firm, and the partners vote themselves a bonus at the end of the year. The entire idea behind the concept “APC drops as income rises” is that this family SAVES THE ENTIRE $10,000 in “extra” income earned in 2019. They want for NOTHING. The extra $10,000 arrives at the end of the year—perhaps not as a surprise, but perhaps as a bonus that could not be guaranteed. This high income family has a great ABILITY to save this extra $10,000, and they have a great INCENTIVE to save it: AN ACTUAL HUMAN BEING IS TELLING THEM, FACE TO FACE, TO SAVE THAT MONEY! They have their own ‘personal savings coach’---whom they PAY—to advise them to save the money instead of spending it. They have things to spend the money on. They want a new car--- that 2020 Tesla is so pretty. Their 2016 Tesla is getting old. The neighbors are talking. Friends are refusing to go to lunch with them because their car is so old…okay… I am being silly. Yet, they DO have things they want to buy. They exercise some ‘discipline’ by NOT buying the newest toy. If they save the entire amount, their MPC on the extra $10,000 is: (a rise in spending of $0) divided by (a rise in net income of +$10,000) = a 0.00 MPC. Their APC drops from .80 in 2018 to: (spending of $80,000) divided by (net income of $110,000) = .73 APC---- “proof”--- if you will---that APC drops as income rises. I would like to point out that this $10,000 will be ‘accounted for’ as household savings---yet, later in the year, as this limited partnership uses the money to drill for oil, we will call that $10,000 part of BUSINESS SPENDING. We will discuss business spending a little later in the course. PORTRAIT #4: “Inflation has made the Jones family ‘feel so poor’… that they are now saving an EXTRA $100 per week”----this is kind of a trick question, or trick portrait, as inflation causes MOST American families to SAVE LESS MONEY over time, not more—well, to be more specific, the fact that a family’s pay raise DOES NOT KEEP UP WITH INFLATION over time helps explain the drop in the average household savings rate. Let’s say that this family earns $61,000 in gross income, pays $21,000 in taxes, clears $40,000 in net income, and, before this ‘great awakening’, spends $38,500 and saves $1,500 per year. We have established this model as the ‘typical’ American household. This works out to a monthly net income of $3,333 per month, and a monthly spending level of $3,208 per month. What would it take for this family to save ANOTHER $100 per week, or $5,200 per year, or $430 per month? Let’s look at this on a monthly basis: in order for this family, or any family, to save $430 a month more, they would have to spend $430 a month LESS. The drop in spending of $430 per month would involve a lot more than this family simply not going out to dinner--- it is a 13% drop in spending! Housing costs tend to be stable—they do not drop from month to month. Food costs are rising every year, and every month. The ONLY fact situation that I can see to explain this is if this family has a $430 per month car payment--- and it ends! Imagine that! 25 years ago, the average car payment was for about 48 months. Now, the average payment plan spans 67 months, with many car loans taking 84 months or longer to pay off. Some luxury cars may have 120 month payment plans. What is my point? THERE ARE FEWER FAMILIES IN AMERICA EVERY YEAR WHO WILL BE IN THIS SITUATION. Thus, the savings rate drops, and continues to drop. Let’s say that we are in ‘normal times’. When this family ‘pays off’ this car, it has a huge decision to make: it can SAVE this $430 each month… or it can go out and buy a new car, which will cost, say, $510 per month. This is a HUGE decision point for this family. If they do the right thing, they an now earn $40,000 per year and spend only $33,300 per year while saving $6,700 per year--- $5,200 more than their previous saving level of $1,500 per year. They would be helping the U.S. economy, as this money will be placed in the ‘loan pool’, or the financial and capital markets, where banks, or other lenders, will lend this same money to businesses that may build housing units or factories with THAT MONEY--- a savings rate of 8% is more beneficial to our economy, compared to a savings rate of 4%. Now, the Jones family is only one family---but a rise in the U.S. savings rate will start with one family at a time. I should mention the concept of ‘leasing’ a car. A family that leases a car will NEVER OWN that car--- they will NEVER ‘pay it off’ and thus be in the situation of the Jones family. If I lease a car for three years, at the end of the lease agreement, I go back to the car dealership and lease another car for another three years--- in theory, the car payments never end until the day I die. This helps contribute to the drop in the savings rate. Another way for this family to ‘pay off’ an old loan is if they incurred STUDENT LOAN DEBT earlier in their lives. I just read that about 45 million Americans owe about $1.6 trillion in total student loan debt, 92% of which is backed in some way by the federal government. This is just a bit larger than the TOTAL CREDIT CARD DEBT owed by American households. My friend Dave graduated from law school at Santa Clara U. owing $65,000 in student loan debt. He has to pay about $500 per month for the next 12 years—about 144 months. This works out to a low rate of interest, but debt is still debt. ONCE HE FINALLY PAYS OFF HIS STUDENT LOANS, he can, in theory, ‘save’ that $500 per month. Student loan debt is now so large that it impacts the national economy: many people in their late 20s and 30s delay getting married, having kids, or buying a house because they owe so much money in student loan debt. There is a movement to ‘forgive’ some or all of that debt, and you have to form your own opinion on this issue. This extra $500 each month that my friend must pay… hurts his ability To save money.
Please answer the following questions:

1. Let's say that in 2019, Mary Jones was employed all year at a job making $61,000 in wages, that is, gross income, and, after $21,000 was "taken out" in various taxes and fees, she was clearing $40,000 per year in net income. Let's say that this is the only source of income for her family. She and her family spent $39,000 and saved the other $1,000. What is her A.P.C.? Is this good for our economy, in your opinion? Or bad? WHY? If she earns a pay raise of $1,000 after taxes, and spends $700 of it, what is her M.P.C.? Is this good for our economy? Or bad? Why? What happens to the other $300?

2. In Jan. 2020 Mary Jones was earning $40,000 in net income and spending $39,000 on a yearly basis. Mary Jones loses her job on April 1, 2020, and regains the same job ---at the same pay ---exactly six months later on October 1, 2020. During the six month layoff period, in the first three months, April, May and June, she earns $600 a week in EXTRA unemployment benefits -- IN ADDITION TO the $347 a week he earns, which is the average UI benefit for the workers in our state. Thus, for these 13 weeks, she earns $947 per week. In the next three months, July, August and September, she earns $347 per week in UI benefits. She and her family cut back on their spending by ten percent during the six months duration of unemployment, but then they go back to spending $39,000 on a yearly basis after he goes back to work. What is her net income level and spending level for 2020? What is his A.P.C. for the year?

3. Do you think that the $600 per week EXTRA in UI benefits is overly generous? Why or why not? Should the $600 per week in EXTRA unemployment benefits be reinstated for the tens of millions of people who had a job in Jan. 2020 but do not have a job now? Why or why not?

4. Millions of people who lose their jobs in America also lose their health insurance. Should this be changed? If so, how? Is access to medical care a right? Should it be? Why or why not?

5. What four "hurdles" must a worker overcome in order to receive unemployment benefits, at least in theory?

Solutions

Expert Solution

1. Here pointed that Mary Jones Gross income in 2019 is $61,000

Charges of various taxes and fees is $21,000

Net income is $40,000

Spenting Money or expenses of her family is $39,000

So the A.P.C (Average Propensity to Consume=is the fraction of income spent. It is computed by dividing consumption by income, or A P C = C /Y.

So.A.P.C=$39,000/$40,000, =0.975

APC refers to Average Propensity to Consume which defines the amount of consumption in every 1 rupee of income for all level of income which can be more than 1 as long as consumption is more national income, i.e. before the break-even point, APC > 1.Here the figure shows less than 1 and it is good to our economy.If the figure greater than 1 it is bad to our economy ,because the consumption is more than the national income inour economy.It provide a bad effect to our economy.

Then the M.P.C (Marginal Propensity to Consume) is the proportion of an increase in income that gets spent on consumption.

MPC, is marginal consumption divided by marginal income.

Here marginal consumption is $700 and marginal income is $1,000.

So M.P.C= $700/$1,000.,=0.7

Marginal Propensity to consume refers to the ratio between the percentage change in consumption for every one rupee of change in the income. Therefore, it cannot be more than 1 as it is percentage change in consumption when there is some change in the level of income which cannot be more than the change in income.Here the figure shows that less than 1,so it is good for our economy.The higher the income will show a lower M.P.C ,it is good to our economy ,otherwise M.P.C greater figure will provide a bad to our economy.

In this problem shows an amount $300 after spenting $700 out of the marginal income amounted $1000 thats a savings to Mary Jones for satisfying future needs and desires.


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