Question

Please solve this to practice the concept of MPC and MPS and how to calculate consumption, GDP and saving in a closed economy with only households.

1. Answer the question on the basis of the following consumption schedule: C = 20 + .9Y, where C is consumption and Y is disposable income. What is the MPC and What is MPS?

2. Tessa's break-even income is $10,000 and her MPC is 0.75. If her actual disposable income is $16,000 how much does she save?

3. If DI is $275 billion and the APC is 0.8, then how much is the saving in this economy? (Hint: Use APC to estimate C for $275 billion of DI)

4. If S = -200 + .15Y, where S is saving and Y is disposable income. What is the MPC? What is the schedule for C?

Answer 1

1)

Consumption function is given by:

C = Co + cY where Co = Autonomous consumption , c = MPC and Y = Disposable Income.

Here,  C = 20 + .9Y

Comparing the above two equation we get Co = Autonomous Consumption = 20

MPC = c = 0.9

Hence, MPC = 0.9

As MPS + MPC = 1 => MPS = 1 - 0.9 = 0.1

Hence MPS = 0.1

2)

Tessa Break even Income = 10,000 but he his is earning disposable income of 16000 and hence excess amount he is having = 6000 from which he will save according to MPS.

MPS = 1 - MPC =1 - 0.75 = 0.25

Hence Amount he is saving is excess income*MPS = 0.25*6000 = 1500

Hence Amount he is saving = $1500

3)

APC = C/DI => C = APC*Y here APC = 0.8 and DI = 275 billion

=> C = 0.8*275 billion = 220 billion

Hence S = DI - C = 275 billion - 220 billion = 55 billion

Hence, Saving = $55 billion

4)

S = -200 + .15Y  

Saving is given by:

S = -Co + (MPS)Y = -Co + (1 - MPC)Y

Comparing above 2 equations we get:

Co (Autonomous consumption) = 200

1 - MPC = MPS = 0.15

=> MPC = 0.85

Consumption function is given by:

C = Co + cY where Co = Autonomous consumption , c = MPC

Hence C = 200 + 0.85Y