Question

Disposable income in the country of Islandia grew from 2010 to 2017 as shown in the table below. If the country’s marginal propensity to consume is 0.8, and in 2010 the level of consumption spending was $250 million, answer the following questions. Year Disposable income (millions of dollars) 2010 $200 2011 $210 2012 $240 2013 $260 2014 $290 2015 $310 2016 $340 2017 $370 a) Calculate the level of consumption spending for each year. b) What is the aggregate autonomous consumption spending for Islandia? What does this mean? c) What is the country’s aggregate consumption function?

Answer 1

(a) Aggregate Consumption function is

C = a + bY

where

a: Autonomous consumption

b: MPC = 0.8 and

Y: Disposable income

In 2010, Y = $200 million, C = $250 million and b = 0.8.

250 = a + 0.8 x 200

250 = a + 160

a = $90 million

Therefore, Consumption function is of the form

C ($ million) = 90 + 0.8Y

Year	Y ($M)	C ($M)
2010	200	250
2011	210	258
2012	240	282
2013	260	298
2014	290	322
2015	310	338
2016	340	362
2017	370	386

(b) Aggregate autonomous consumption spending = $90 million (derived in part (a).

This signifies that even if disposable income is zero and the consumers have no income (or they pay the entire income as tax), the economy will spend $90 million for consumption expenditure and this is the subsistence level of consumption expenditure.

(c) Aggregate consumption function: C ($ million) = 90 + 0.8Y