Consider an economy characterized by the following components (all values are in
ID: 1213808 • Letter: C
Question
Consider an economy characterized by the following components (all values are in $ billions): C = 5 + 0.8Yd 1=10 G = 15 t = 0.1 m = 0.07 X = 5 What is the marginal propensity to save? In words, explain what the value for the marginal propensity to save implies. (1 mark) Determine the aggregate expenditure function. (2.5 marks) What is the marginal propensity to spend? In words, explain what the value for the marginal propensity to spend implies. (2 marks) Find the equilibrium level of national income. (2 marks) Suppose that desired government expenditure increases to $30 billion. What happens to the equilibrium level of national income?Explanation / Answer
Answer:
Given the information:
C = 5 + 0.8YD
I = 10
G = 15
t = 0.1
m = 0.07
X = 5
Consumption (C) = 5 + 0.8(Y-0.1)
C = 4.92 + 0.8Y
d) The equilibrium level of national income is:
Y = C + I + G + (X-M)
Y = 4.92 + 0.8Y + 10 + 15 + 4.93
0.2Y = 34.85
Y = 174.25
Now C = 4.92 + 0.8(174.25)
C = 144.32
Saving = Y – C
= 174.25 - 144.32
S = 29.93
a) What is the marginal propensity to save? In words, explain what the value for the marginal propensity to save implies.
The marginal propensity to save is the proportion of each additional dollar of household income that is used for saving. It can be measured as: Change in savings/Change in Income
That is: MPS = S/Y
MPS = 29.93/174.25
MPS = 0.17
b) Determine the aggregate expenditure function.
AE = C + I + G + (X-M)
= 4.92 + 0.8(174.25) + 10 + 15 + 4.93
AE = 174.25
c) What is the marginal propensity to spend? In words, explain what the value for the marginal propensity to spend implies.
The increase in personal consumer spending (consumption) occurs with an increase in disposable income (income after taxes and transfers). Simply, the ratio of change in consumption (C) due to change in income (Y) is called marginal propensity to consume.
MPC = C/Y
MPS = 144.32/174.25
MPS = 0.82