Question

Assume that you define your permanent income as the average of your current income plus your income over the past four years. Your earnings record over these years has been: Yt = $39,000; Yt-1 = $37,000; Yt-2 = $35,000; Yt-3 = $33,000; and Yt-4 = $32,000.

(a) What is your permanent income in this period, YPt?

(b) If next year, your income increases to Yt+1 = $45,000, what is your permanent income next year, YPt+1?

(c) By how much will your consumption change between year t and year t+1 if you always consume 90 percent of your permanent income?

(d) What is your long-run MPC?

(e) What is your short-run MPC?

Answer 1

Long run MPC depends on permanent income of the individual while the short run MPC depends on the transitory income of the individual which is greater for high income groups and less for lower Income groups .

D) long run MPC In period t+1 = change in consumption in period t+1 divided by change in permanent income in period t+1

= 34020-31680/37800-35200

=2340/2600

=0.9

E) Short run MPC will depend on the normal income in period Yt and Yt+1 not on the permanent income .