Question

Let

AE =C+I+G+NX
where AE is the aggregate expenditure, C is the consumption function, I is investment,

G is government expenditure and NX is the net export. Given C = 100 + 0.65Y

where Y is the national income and
I = 100, G = 100+0.10Y, NX = 0

1. (a) Graph the consumption function with Y on the horizontal axis and C on the vertical axis.

2. (b) Graph the aggregate expenditure function with Y on the horizontal axis and AE on the vertical axis.

3. (c) Find the equilibrium level of income without using graph analytically.

4. (d) Find the equilibrium level of consumption C.

Answer 1

(a) Graph the consumption function with Y on the horizontal axis and C on the vertical axis.

The consumption function represents the functional relationship between total consumption and and total income.

It is given by C = 100 + 0.65Y

(b) Graph the aggregate expenditure function with Y on the horizontal axis and AE on the vertical axis.

Aggregate expenditure is the current value of all the finished goods and services in the economy. The equation for aggregate expenditure is:

AE = C + I + G + NX

AE = 100 + 0.65Y + 100 + 100+0.10Y + 0

AE = 300 + 0.75Y

(c) Find the equilibrium level of income without using graph analytically.

Aggregate expenditure in the economy is equal to output, or national income

Y = C + I + G + NX

Y = 100 + 0.65Y + 100 + 100 + 0.10Y + 0

Y = 300 + 0.75Y

Y - 0.75Y= 300

0.25Y =300

Y = 300/0.25

Y = 1200

The equilibrium level of income in the economy is equal to 1200

(d) Find the equilibrium level of consumption C.

Consumption at equlibrium income at equilibrium income Y = 1200 is,

C = 100 + 0.65Y

C = 100 + 0.65 * 1200

C = 100 + 780

C = 880

The equilibrium level of consumption C = 880