Question

a."Explain why unplanned inventory changes are not considered part of aggregate expenditure.

b.You receive $1,000. How much of it will you spend this year and how much of it will you save? What is your marginal propensity to consume?"

Answer 1

Ans --- (a)

Unplanned inventory Investment

Unplanned change in inventory Investment is the difference between real gdp and aggregate Expenditure. It iccurs when-----

Real gdp≠ AE( aggregate Expenditure)

Unplanned increase in inventory Investment implies that AE<Real GdP which makes the firms to decrease Production/ employment

Unplanned Decrease in inventory Investment means AE>real gdp which makes firms to increase production/ employment

Unplanned inventory changes are not considered as a part of aggregate Expenditure because adding such amount means firms are not meeting their planned or desired Investment behaviour.

Rhat is why , while calculating AE, we add up planned Investment Expenditure and donot consider unplanned inventory Investment changes.

Ans (b) MPC, Consumption and saving

Income (Y)=$ 1000

Let my MPC =0•75

Spending = 1000×0•75=$750

Saving= 1000×(1-0•75)=$2500

Explanation-----

# Marginal Propensity to consume ( MPC) is the ratio of change in Consumption to change in income.

MPC=∆C/∆Y

# MPS( Marginal Propensity to save) = 1-MPC

=1-0•75=0•25

# portion of income spent on Consumption (C)= 1000×0•75=$750

# portion of income saved= 1000×0•25=$250