Consider an economy in which taxes, planned investments, government spending on
ID: 1247629 • Letter: C
Question
Consider an economy in which taxes, planned investments, government spending on goods and services, and net exports are autonomous, but consumption and planned investment change as the interest rate changes. You are given the following information concerning autonomous consumption, the marginal propensity to consume, planned investment, government purchases of goods and services, and net exports:Ca=1500-10r c=0.6 T=1800 Ip=2400-50r G=2000 NX=-200
(a) Compute the value of the marginal propensity to save.
(b) Compute the amount of autonomous planned spending, Ap, given that the interest rate equals 5.
(c) Compute the equilibrium level of income, given that the interest rate equals 5.
(d)Suppose that autonomous consumption changes by 4 percent of any change in household wealth and that the decline in the housing market in 2006-07 and drop in the stock market in the summer of 2007 reduces household wealth by $750 billion. Compute the decrease in autonomous consumption that results from the decline in household wealth.
Explanation / Answer
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a. The marginal propensity to save equals: 1-C=1-0.6=0.4
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b. Autonomous planned spending, Ap, equals Ca ? cTa + Ip + G + NX = 1,500 ? 10r ?.6(1,800) + 2,400 ? 50r + 2,000 ? 200 = 4,620 ? 60r.
Therefore, at an interest rate equal to 3, autonomous planned spending equals 4,620 ? 60(3) = 4,440.
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c. Since the marginal propensity to save equals 0.4 and the equilibrium level of income equals Ap /s, the equilibrium level of income equals 4,440/.4 = 11,100, given the interest rate equals 3.
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d. Since autonomous consumption changes by four percent of any change in household wealth and the decline in the housing market in 2006