Question

Let AE = C +I +G+NX where AE is the aggregate expenditure, C is the consumption function, I is investment, G is government expenditure and NX is the net export.

Given C = 100+0.65Y where Y is the national income and I = 100, G = 100+0.10Y, NX = 0

(a) Graph the consumption function with Y on the horizontal axis and C on the vertical axis.

(b) Graph the aggregate expenditure function with Y on the horizontal axis and AE on the vertical axis.

(c) Find the equilibrium level of income without using graph analytically.

(d) Find the equilibrium level of consumption C.

Answer 1

Consumption: C = 100 + 0.65.Y

Investment: I = 100

Government Expenditure: G = 100 + 0.1.Y

Net Exports: NX = 0

Aggrigate Expenditure is

AE = C + I + G + NX

or, AE = 100+0.65.Y+100+100+0.1.Y+0

or, AE = 300 + 0.75.Y

(a) The consumption function is drawn in the following diagram.

(b) The aggrigate expenditure function is drawn in the following diagram.

(c) At equilibrum,

AE = Y

or, 300 + 0.75.Y = Y

or, 0.25.Y = 300

or, Y* = 1200

Equilibrum income is 1200.

(d) The equilibrum level of consumption is

C* = 100 + 0.65.Y* = 100 + 0.65×1200

or, C* = 880

Equilibrum consumption is 880.

Hope the solutions and diagrams are clear to you my friend.