Question

AE = C + I + G + (X-M)

C – Consumption

I – Investment

G – Government Spending

X – Exports

M – Imports

AE = Y

Y = Income/Output

C = Autonomous Consumption (a) + Marginal Propensity to Consume (MPC)*Y

            i. Autonomous Consumption (a) – Consumption from Wealth (Past Savings)

            *Autonomous Consumption can also be affected by Expectations, Household Debt, and Taxes.     ii. Marginal Propensity to Consume (MPC) – The percentage of every new dollar of income that is directed toward consumption.

Given:

            a = 100

            I = 500

            G = 500

            X = 200

            M = 300

            *For every ∆Y = 100, there is a ∆C = 80.

True/False. Explain each of the points below.

                i. The multiplier (k) = 5.

                ii. If Y = 1000 and a = 100, then C = 600

                iii. If Y = 2000 and a = 100, then C = 1100.

Answer 1

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Solution i)

Hence, Multiplier is 5

so, it is true.

Solution ii).  

MPC = 0.8

when Y = 1000 and a = 100

C = a + MPC*Y = 100 + 0.8(1000) = 100 + 800 = 900

hence it is not true C = 900 not 600

Solution iii)

MPC = 0.8

when Y = 2000 and a = 100

C = a + MPC*Y = 100 + 0.8(2000) = 100 + 1600 = 1700

hence it is not true C = 1700 not 1100