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Chapter 23: Problem 8

Draw the consumption function and label each axis. Show the effect of an increase in income on consumption spending. Does the change in income cause a movement along the consumption function or a shift of the consumption function? How would an increase in expected future income or an increase in household wealth affect the consumption function? Would these increases cause a movement along the consumption function or a shift of the consumption function? Briefly explain.

Short Answer

Expert verified
An increase in income causes a movement along the consumption function, while an increase in expected future income or household wealth causes a shift of the consumption function. The reason for the shift is that consumers are likely to spend more at all levels of income when they expect more future income or have greater household wealth.

Step by step solution

01

Drawing the Consumption Function

Plot a two-dimensional graph with income on the x-axis and consumption on the y-axis. The consumption function is typically an upward sloping straight line, starting with some value of consumption at a zero level of income. This demonstrates that even without income, there can be some level of consumption (due to savings or borrowing). The slope of the line indicates the marginal propensity to consume (the increase in consumption for each additional unit of income).
02

Effect of an Increase in Income

An increase in income would be represented on the graph as a movement to the right along the x-axis (income axis). Consumption spending increases as the income increases, hence we move upward along the consumption function. This is a movement along the consumption function.
03

Effect of an Increase in Future Expected Income or Household Wealth

An increase in expected future income or an increase in household wealth is likely to influence consumer behavior by making them feel wealthier, thereby increasing their current consumption. This would result in a new consumption function above the current one since for any given level of income, consumption would be greater than it was before. This is a shift of the consumption function.

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Most popular questions from this chapter

A Federal Reserve publication noted that "the shedding of unwanted inventories often accounts for a large portion of the decline in gross domestic product (GDP) during economic recessions." What does the author mean be "shedding of unwanted inventories"? What makes the inventories unwanted? Why would shedding inventories lead to a decline in GDP?

An article in the Wall Street Journal stated, "Europe is entering its fifth consecutive year of growth, supported by accommodative monetary policies, robust business and consumer confidence and improving world trade." What components of aggregate expenditure would "robust business and consumer confidence and improving world trade” affect, and why would they cause real GDP to grow? Illustrate your answer with a \(45^{\circ}\) -line diagram.

(Related to Solved Problem 23.4 on page 807 ) Use the information in the following table to answer the questions. Assume that the values represent billions of 2009 dollars. $$ \begin{array}{r|r|r|r|r} \hline \begin{array}{c} \text { Real } \\ \text { GDP } \\ (Y) \end{array} & \begin{array}{c} \text { Planned } \\ \text { Consumption } \end{array} & \begin{array}{c} \text { Investment } \\ \text { (C) } \end{array} & \begin{array}{c} \text { Government } \\ \text { Purchases } \end{array} & \begin{array}{c} \text { Net } \\ \text { Exports } \end{array} \\ \hline \$ 8,000 & \$ 7,300 & \$ 1,000 & (G) & (N X) \\ \hline 9,000 & 7,900 & 1,000 & 1,000 & -\$ 500 \\ \hline 10,000 & 8,500 & 1,000 & 1,000 & -500 \\ \hline 11,000 & 9,100 & 1,000 & 1,000 & -500 \\ \hline 12,000 & 9,700 & 1,000 & 1,000 & -500 \\ \hline \end{array} $$ a. What is the equilibrium level of real GDP? b. What is the MPC? c. Suppose net exports increase by \(\$ 400\) billion. What will be the new equilibrium level of real GDP? Use the multiplier formula to determine your answer.

What are the five main determinants of consumption spending? Which of these is the most important? How would a rise in stock prices or housing prices affect consumption spending?

In the aggregate expenditure model, why is it important to know the factors that determine consumption spending, investment spending, government purchases, and net exports?
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