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Chapter 21: Q 19. (page 567)

Assume that autonomous consumption is \(1,625 billion and disposable income is \)11,500 billion. Calculate consumption expenditure if an increase of \(1,000 in

disposable income leads to an increase of \)750 in consumption expenditure

Short Answer

Expert verified

Consumption Expenditure = 10250

Step by step solution

01

Step 1. Introduction

Consumption function shows the corresponding values of consumption at various levels of income, by a functional relationship between income & consumption.

Consumption Function = a + b Yd; where Y = Disposable (after tax) Income

a = autonomous consumption, ie consumption at zero level of income

b = marginal propensity to consume, ie ratio showing responsive change in consumption due to change in income. {Formula = Change in Consumption / Change in Income}

02

Numerical Solution 

As increase in disposable income by 1000 increases consumption expenditure by 750, so MPC = 750 / 1000 = 0.75

Autonomous Consumption = 1625 & Income = 11500 implies that :

Consumption = 1625 + 0.75 (11500) = 1625 + 8625

= 10250

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Most popular questions from this chapter

Why do companies cut production when they find that their unplanned inventory investment is greater than zero? If they didn’t cut production, what effect would

this have on their profits? Why?

Go to http://www.eurmacro.unisg.ch/Tutor/islm.html. Set the policy instruments to G = 80, t = 0.20, c = 0.75, and b = 40. Now increase government spending, G, from 80 to 160. By how much does the IS curve shift horizontally to the right? Why is the amount of shift greater than the increase in G? Now increase the marginal propensity to consume, c, from 0.75 to 0.90. In which direction does the IS curve shift, and why? By how much does it shift? Now increase the tax rate, t, from 0.20 to 0.28. In which direction does the IS curve shift, and why? By how much does it shift?

Go to the St. Louis Federal Reserve FRED database, and find data on Real Private Domestic Investment (GPDIC1), a measure of the real interest rate; the 10-year Treasury Inflation-Indexed Security, TIIS (FII10); and the spread between Baa corporate bonds and the 10-year U.S. treasury (BAA10YM), a measure of financial frictions. For (FII10) and (BAA10YM), convert the frequency setting to “quarterly,” and download the data into a spreadsheet. For each quarter, add the (FII10) and (BAA10YM) series to create ri , the real interest rate for investments for that quarter. Then calculate the change in both investment and ri as the change in each variable from the previous quarter.

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c. Take the ratio of your answer from part (a) divided by your answer from part (b). What does this value represent? Briefly explain.

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