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15. Consider a simple product market with constant price and no international trade. Investment and government...

15. Consider a simple product market with constant price and no international trade. Investment and government expenditures are exogenously given. The marginal propensity to consume is between zero and one. Ignore the money market (or assume that the interest rate is constant). Now suppose autonomous savings increase (that is autonomous consumption declines). a. Show graphically how this shock would affect the equilibrium levels of income and consumption. Explain your answer. b. What would be the impact of this shock on the equilibrium levels of savings and investment? Explain

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Answer #1

Autonomous Consumption is the level of consumption expenditure when income is 0

It is the value of intercept on the y-axis in the consumption income model, representing the value of AE when income is 0

A fall in autonomous Consumption will shift the consumption curve down from the y-axis intercept.

This will shift the equilibrium from point X to point Y

As a result, equilibrium levels of income and consumption will fall.

As incomes fall, both savings and investment in the economy would also fall.

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