12-2. Consider the table below when answering the following questions. For this
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Question
12-2. Consider the table below when answering the following questions. For this hypothetical economy, the marginal propensity to save is constant at all levels of real GDP, and investment spending is autonomous. There is no government.
a. Complete the table. What is the marginal propensity to save? What is the marginal propensity to consume?
b. Draw a graph of the consumption function. Then add the investment function to obtain C + I.
c. Under the graph of C + I, draw another graph showing the saving and investment curves. Note that the C + I curve crosses the 45-degree reference line in the upper graph at the same level of real GDP where the saving and investment curves cross in the lower graph. (If not, redraw your graphs.) What is this level of real GDP?
d. What is the numerical value of the multiplier?
e. What is equilibrium real GDP without investment?
What is the multiplier effect from the inclusion of investment?
f. What is the average propensity to consume at equilibrium real GDP?
g. If autonomous investment declines from $400 to $200, what happens to equilibrium real GDP?
Explanation / Answer
Since you have not given any detail on Chart so
a)The proportion of an aggregate raise in pay that a consumer spends on the consumption of goods and services, as opposed to saving it. Marginal propensity to consume is a component of Keynesian macroeconomic theory and is calculated as the change in consumption divided by the change in income. MPC is depicted by a consumption line- a sloped line created by plotting change in consumption on the vertical y axis and change in income on the horizontal x axis.
The marginal propensity to consume (MPC) is equal to ?C / ?Y, where ?C is change in consumption, and ?Y is change in income. If consumption increases by 80 cents for each additional dollar of income, then MPC is equal to 0.8 / 1 = 0.8.
The proportion of an aggregate raise in pay that a consumer spends on saving rather than on the consumption of goods and services. Marginal propensity to save is a component of Keynesian macroeconomic theory and is calculated as the change in savings divided by the change in income.
Marginal propensity to save= change in saving/change in income
MPS is depicted by a savings line: a sloped line created by plotting change in savings on the vertical y axis and change in income on the horizontal x axis.
b)The consumption function is the starting point in the Keynesian economics analysis of equilibrium output determination. It captures the fundamental psychological law put forth by John Maynard Keynes that consumption expenditures by the household sector depend on income and than only a portion of additional income is used for consumption.
This function is presented either as a mathematical equation, most often as a simple linear equation, or as the graphical consumption line. In either form, consumption is measured by consumption expenditures and income is measured as disposable income, national income, or occasionally gross domestic product.
The primary purpose of the consumption function the basic consumption-income relation for the household sector, which is the foundation of the aggregate expenditures line used in Keynesian economics.
The consumption function makes it easy to divide consumption into two basic types. Autonomous consumption is the intercept term. Induced consumption is the slope. Of no small importance, the slope of the consumption function is also the marginal propensity to consume (MPC).
First, The Equation
The consumption function can represented in a general form as:
C=f(Y)
where: C is consumption expenditures, Y is income (national or disposable), and f is the notation for a generic, unspecified functional form.
Depending on the analysis, the actual functional form of the equation can be linear, with a constant slope, or curvilinear, with a changing slope. The most common form is linear, such as the one presented here:
C=a+bY
where: C is consumption expenditures, Y is income (national or disposable), a is the intercept, and b is the slope.
The two key parameters that characterize the consumption function are slope and intercept.
Slope: The slope of the consumption function (b) measures the change in consumption resulting from a change in income. If income changes by $1, then consumption changes by $b. This slope is generally assumed and empirically documented to be greater than zero, but less than one (0 < b < 1). It is conceptually identified as induced consumption and the marginal propensity to consume (MPC).
Intercept: The intercept of the consumption function (a) measures the amount of consumption undertaken if income is zero. If income is zero, then consumption is $a. The intercept is generally assumed and empirically documented to be positive (0 < a). It is conceptually identified as autonomous consumption.
c) graph needed
d) The slope of the aggregate expenditures line determines the magnitude of the multiplier process and the numerical value of the multiplier. In particular, the expenditures multiplier is the inverse of one minus the slope of the aggregate expenditures line. This slope is largely based on the marginal propensity to consume, but also depends on other induced activities. A steeper slope generates a larger multiplier and a flatter slope leads to a smaller multiplier.
The standard Keynesian expenditures multiplier is the inverse of one minus the slope of the aggregate expenditures line. The slope of the aggregate expenditures line captures the extent to which consumption expenditures, investment expenditures, government purchases, and other macroeconomic activities are induced by aggregate production and income. If the slope is steeper and aggregate expenditures are induced more by aggregate production, then the multiplier is greater.
The Multiplier Formula
The total change in aggregate production caused by an autonomous expenditure change depends on the extent to which consumption and other expenditures are induced by income.
Consider if you will the simple formula for the multiplier m stated in terms of the marginal propensity to consume and the marginal propensity to save.
m = 1marginal propensity to save = 1(1 - marginal propensity to consume)
For example, if 75 percent of the income received by the household sector is used for consumption (a marginal propensity to consume of 0.75) then the multiplier is 4. A larger marginal propensity to consume means a larger multiplier. A smaller marginal propensity to consume means a smaller multiplier. If the marginal propensity to consume is 0.9, then the multiplier is 10. If the marginal propensity to consume is 0.6, then the multiplier is 2.5.
e)To determine whether there's an output gap we'll need to calculate the amount of equilibrium GDP and then compare that level of GDP to the amount of potential GDP.
We'll begin by considering a simple, hypothetical economy. Assume that, within this simple economy, the price level remains constant and that various other conditions exist which allow us to express aggregate expenditures in terms of a series of equations. Let's look at those equations, ask what they tell us, and then proceed to find how much real GDP must be produced in order to satisfy the demands of this macroeconomy (i.e. we'll find equilibrium GDP, or Y*)
The various expenditure categories within the economy, as well as potential real GDP, are:
C = 0.75(DI) + 400 (C = consumption expenditure, DI = disposable income)
I = 1200 (I = investment expenditure)
G = 1600 (G = government expenditure)
X = 500 (X = exports)
M = 600 (M = imports)
T = 1200 (T = tax revenue)
Yp = 9000 (Yp = potential real GDP)
What do these equations mean?
The consumption equation, C = 0.75(DI) + 400, tells us that the marginal propensity to consume is 0.75. That is, every $1 increase in disposable income leads to a 75 cent increase in consumption spending. This provides us with information about how quickly consumers spend any available income. A greater MPC implies that consumers are likely to spend more now, rather than save.
The investment equation, I = 1200, tells us that investment spending (which generally includes expenditure on new capital and unintended changes in inventories) does not vary with changes in variables like GDP and interest rates. That is, if the economy begins to climb out of recession, investors don
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