Question

4. Keynesian Economics

a.What is the Keynesian consumption function?
b.What is the marginal propensity to consume?

c.Reread the textbook material on the simple Keynesian model (pp.258–263, pp 226-230 in the eleventh edition).

             i. What is the multiplier?

             ii. Suppose the marginal propensity to consume is 0.75.Compute the multiplier

             iii. Given the value you computed for the multiplier, compute the amount by which real GDP

increases, when the government increases purchases by $100 billion.

(Note:The value of the mpc and investment expenditures is different than the example cited in the book, but the principle is the same.

Answer 1

The Keynesian consumption function is

C= Cbar + cY, where Cbar is the autonomous consumption that happens even at 0 income and c is the Marginal propensity to consume, Y is income.

The Marginal Propensity to Consume is the proportion of income that one consumes. It is the part of the penny that is consumed. If MPC=0.8, then out of an income of 100, 80 will be consumed.

The multiplier is the value by which the income changes due to a change in the parameters of the model. Generally the income increases by more than 100 %

Multiplier= 1/1-MPC

If MPC= 0.75, multiplier= 1/0.25=4

Therefore if the government increases purchases by $100 billion, thn income increases by $400 billion