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In: Economics

Consider a hypothetical economy in which the marginal propensity to consume (MPC) is 0.50. That is,...

Consider a hypothetical economy in which the marginal propensity to consume (MPC) is 0.50. That is, if disposable income increases by $1, consumption increases by 50¢.

Suppose further that last year disposable income in the economy was $400 billion and consumption was $300 billion.

On the following graph, use the blue line (circle symbol) to plot this economy's consumption function based on these data.

01002003004005006007008007006005004003002001000-100CONSUMPTION (Billions of dollars)DISPOSABLE INCOME (Billions of dollars)Y-Intercept: 100Slope: 0

From the preceding data, you know that the level of savings in the economy last year was

billion and the marginal propensity to save in this economy is

.Suppose that this year, disposable income is projected to be $500 billion. Based on your analysis, you would expect consumption to be

billion and savings to be

billion.

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Expert Solution

General form of consumption function: C = C0 + MPC*Yd

Where C ic consumption

C0 is autonomous consumption

MPC is marginal propensity to consume

Yd is disposable income.

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

Consider a hypothetical economy in which the marginal propensity to consume (MPC) is 0.50. That is, if disposable income increases by $1, consumption increases by 50¢.

=> MPC = 0.50

Suppose further that last year disposable income in the economy was $400 billion and consumption was $300 billion.

=> At Yd = $400 billion; C is $300 billion

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

C = C0 + MPC*Yd

Put MPC = 0.5, Yd = $400 billion; C = $300 billion

=> $300 billion = C0 + 0.5($400 billion)

=> $300 billion = C0 + $200 billion

=> C0 = $300 billion - $200 billion

=> Co = $100 billion

The autonomous consumption is $100 billion.

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

Consumption function: C = 100 + 0.5Yd

Note: The C and Yd would be in $ billion.

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

Yd C
0 100
100 150
200 200
300 250
400 300
500 350
600 400
700 450
800 500

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

Disposable income = Consumption + Saving

Suppose further that last year disposable income in the economy was $400 billion and consumption was $300 billion.

=> $400 billion = $300 billion + Saving

=> Saving = $400 billion - $300 billion

=> Saving = $100 billion.

And

MPC +MPS = 1

=> MPS = 1 - MPC
=> MPS = 1 - 0.5

=>MPS = 0.5

Answer: From the preceding data, you know that the level of savings in the economy last year was $100 billion and the marginal propensity to save in this economy is 0.5

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

This year disposable income would be $500 billion

Consumption function: C = 100 + 0.5Yd

Note: The C and Yd would be in $ billion.

Put Yd = 500

=> C = 100 + 0.5(500)

=> C = 100 + 250

=> C = 350

At disposable income of $500 billion, the consumption would be $350 billion.

----

Disposable income = Consumption + Saving

=> $500 billion = $350 billion + Saving

=> Saving = $500 billion - $350 billion

=> Saving = $150 billion.

Answer:

Suppose that this year, disposable income is projected to be $500 billion. Based on your analysis, you would expect consumption to be $350 billion and savings to be $150 billion.

Rahul Sunny answered 1 year ago
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