Question

State whether true or false and explain:

(a) The Keynesian consumption function predicts that the average propensity to consume rises as income increases.

(b) Labour-market reforms that reduce frictions in search and matching will lower the natural rate of unemployment.

Answer 1

(a)

One of the characteristic of Keynesian consumption function is the relation between Average Propensity to Consume APC and Income Y.

APC is defined as = C/Y

As income increases, the APC declines. This is because higher proportion of income is saved.

So, Statement is FALSE

(b)

Natural Rate of Unemployment = s / s + f

where s denotes structural unemployment

f denotes frictional unemployment

Let say s = 5 and f = 7

so, Natural unemployment rate = 5 / 12 = 0.42

Now, due to labor market reforms both s and f decreases to s = 4 and f = 6

New unemployment rate = 0.4

So, the natural rate of unemployment has decreased.

Statement is TRUE