Question

Assume the Kenya’s consumption function is C=1800+0"\.78Yd," suppose the marginal propensity to import (mpm) is 0.15.                                                                                                 
i) What is the autonomous consumption                                                             
ii) Calculate the multiplier assuming an open economy                                 
iii) Calculate the effect of an increase in government spending of 100M Kshs on the country’s
national income.                                                                                               

Answer 1

i) Autonomous consumption is determined when Yd = 0
So, C = 1800 + 0.78Yd = 1800 + 0.78*(0) = 1800

The autonomous consumption is 1800

ii) Multiplier in an open economy = 1/(1-MPC+MPM)
MPC = 0.78 (From consumption function)
So, Multiplier = 1/(1-0.78+0.15) = 1/0.37 = 2.70

The multiplier in an open economy is 2.70

iii) Also, multiplier = Change in Y/Change in G
So, Change in Y = multiplier*Change in G = 2.70*(+100) = 270

Thus, increase in government spending of 100M Kshs on the country’s increases national income by 270M.