Question

Use the table below to solve this problem.

	Level of Output and Income (GDP = DI) Consumption Saving APC APS MPC MPS $480 $488 $-8 1.0167 –0.0167 0.8 0.2 520 520 0 1.0000 0.0000 0.8 0.2 560 552 8 0.9857 0.0143 0.8 0.2 600 584 16 0.9733 0.0267 0.8 0.2 640 616 24 0.9625 0.0375 0.8 0.2 680 648 32 0.9529 0.0471 0.8 0.2 720 680 40 0.9444 0.0556 0.8 0.2 760 712 48 0.9368 0.0632 0.8 0.2 800 744 56 0.9300 0.0700 0.8 0.2

Suppose the wealth effect is such that a $10 change in wealth produces a $1 change in consumption at each level of income. Assume real estate prices tumble such that wealth declines by $160.

Instructions: Enter your answers as whole numbers.

a.What will be the new level of consumption at the $680 billion level of disposable income?

b. What will be the new level of saving?

Answer 1

(a)

It is provided that,

$10 change (increase or decrease) in wealth leads to $1 change (increase or decrease) in consumption at each level of income.

This means that,

A decrease of $10 in wealth leads to $1 decrease in consumption at each level of income.

A decrease of $1 in wealth leads to $(1/10) decrease in consumption at each level of income.

A decrease of $160 billion in wealth leads to [$(1/10) * $160] $16 billion decrease in consumption at each level of income.

When income level is $680 billion, the consumption is $648 billion.

The decline in wealth by $160 billion will reduce consumption by $16 billion.

So,

New level of consumption = Current consumption - reduction in consumption

New level of consumption = $648 billion - $16 billion = $632 billion

The new level of consumption at the $680 billion level of disposable income will be $632 billion.

(b)

Calculate the new level of saving -

New level of saving = Income - new level of consumption

New level of saving = $680 billion - $632 billion = $48 billion

Thus,

The new level of saving is $48 billion.