Consumption Use: The Following Data To Answer The Following

Consumption Use The Following Data To Answer the Following Questi

Use the following data to answer the following questions. Real disposable income (billions), expenditures (billions), and savings (billions):

Income: $100, $200, $300, $400

Expenditures: $150, $250, $300

Savings: $200

a. Graph the consumption function, with consumption spending on the vertical axis and disposable income on the horizontal axis.

b. If the consumption function is a straight line, what is its slope?

c. Fill in the savings column at each level of income. If the savings function is straight line, what is its slope?

2. Consumption Function: How would an increase in each of the following affect the consumption function?

a. Net taxes

b. The interest rate

c. Consumer optimism, or confidence

d. The price level

e. Consumers’ net wealth

f. Disposable income

3. (Simple Spending Multiplier) For each of the following values for the MPC, determine the size of the simple spending multiplier and the total change in real GDP demanded following a $10 billion decrease in spending:

a. MPC= 0.9

b. MPC= 0.75

c. MPC= 0.6

4. (Expansionary and Recessionary Gaps)

a. If the actual price level exceeds the expected price level reflected in long-term contracts, real GDP equals -------- and the actual price level equals ------- in the short run.

b. The situation described in part (a) results in a -------- gap equal to -----.

c. If the actual price level is lower than the expected price level reflected in long-term contracts, real GDP equals ------ and the actual price level equals ------ in the short run.

d. The situation described in part (c) results in a ------ gap equal to -------.

e. If the actual price level equals the expected price level reflected in long-term contracts, real GDP equals ------ and the actual price level equals ------- in the short run.

f. The situation described in part (e) results in ------- gap equal to --------.

5. (Changes in Aggregate Supply) List three factors that can change the economy’s potential output. What is the impact of shifts of the aggregate demand curve on potential output? Illustrate with a diagram.

6. (Supply Shocks) Give an example of an adverse supply shock and illustrate graphically. Do the same for a beneficial supply shock.

Sample Paper For Above instruction

Introduction

The relationship between disposable income and consumption expenditure is fundamental to understanding macroeconomic fluctuations. The consumption function, which illustrates how personal consumption varies with income, serves as a critical component in macroeconomic analysis and policymaking. This paper explores this relationship through graphical and analytical methods, examines the factors influencing consumption and savings, and discusses broader macroeconomic concepts related to supply shocks, aggregate demand, and potential output.

Graphing the Consumption Function and Calculating Its Slope

Using the provided data, we plot real disposable income (horizontal axis) against consumption expenditure (vertical axis). The points are (100, 150), (200, 250), (300, 300), and (400, unknown). Noticing inconsistencies, assuming the expenditures increase at a constant rate, the data suggests a linear relationship. The consumption function can be represented as C = a + bYd, where C is consumption, Yd is disposable income, a is autonomous consumption, and b is the marginal propensity to consume (MPC).

To determine the slope, we analyze the change in consumption relative to change in income. Between income levels of $100 billion and $200 billion:

Change in consumption = $250 billion − $150 billion = $100 billion

Change in income = $200 billion − $100 billion = $100 billion

Thus, the slope (MPC) = 100/100 = 1.0, suggesting consumers spend all additional income, which may be simplistic and indicative of data inconsistency. Alternatively, other data points yield different slopes, but assuming linearity, the slope represents MPC.

Calculating Savings and the Saving Function Slope

Savings at each income level equals disposable income minus consumption expenditure. For example, at $100 billion income:

Savings = $100 billion − $150 billion = -$50 billion (indicating dissaving)

Similarly, at $200 billion income:

Savings = $200 billion − $250 billion = -$50 billion

Savings at $300 billion:

Savings = $300 billion − $300 billion = $0

At $400 billion, data is incomplete, but the pattern suggests savings increase with income, and the slope of the savings function (the marginal propensity to save, MPS) can be calculated accordingly.

Effects of Changes in Components on Consumption Function

An increase in net taxes reduces disposable income, shifting the consumption function downward, indicating less consumption at each income level. Conversely, a decrease in interest rates makes borrowing cheaper, encouraging consumers to spend more, shifting the consumption function upward. Consumer optimism boosts consumer confidence, leading to increased consumption for the same income, shifting the function upward. Conversely, higher price levels tend to reduce real purchasing power, decreasing consumption, shifting the function downward. An increase in net wealth enhances consumers' capacity and willingness to spend, shifting the function outward. Finally, increases in disposable income naturally lead to higher consumption along the existing consumption function, reflecting a movement along the curve rather than a shift.

Multiplier Effects

The simple spending multiplier is calculated as 1/(1−MPC). For MPC=0.9, the multiplier is 10; for MPC=0.75, it is 4; for MPC=0.6, it is approximately 2.5. A decrease in spending by $10 billion results in a total GDP decrease of:

  • For MPC=0.9: $10 billion × 10 = $100 billion
  • For MPC=0.75: $10 billion × 4 = $40 billion
  • For MPC=0.6: $10 billion × 2.5 = $25 billion

Understanding Gaps and Price Level Relationships

In the short run, if the actual price level exceeds the expected level, real GDP equals potential output, but actual prices are higher. This leads to an inflationary gap, where actual GDP surpasses potential GDP, indicating overheating. Conversely, if the actual price level is below expectations, a recessionary gap occurs, with actual GDP below potential. When the actual price level matches expectations, GDP aligns with potential output, indicating an equilibrium in the economy.

Factors Affecting Potential Output

Potential output is influenced by technological progress, capital stock, and labor force size. An increase in technology enhances productivity, shifting the aggregate supply curve outward. Growth in the capital stock through investment expands productive capacity. Additionally, a larger and more skilled labor force contributes to higher potential output. Shifts in aggregate demand influence actual output but do not change potential output unless they induce structural changes in the economy.

Supply Shocks and Their Impacts

An adverse supply shock, such as an oil crisis, reduces aggregate supply, increasing production costs and causing stagflation—rising prices and falling output. Graphically, the short-run aggregate supply curve shifts leftward. Conversely, a beneficial supply shock, like technological innovation, shifts aggregate supply rightward, lowering prices and increasing output. Such shocks play crucial roles in short-term economic fluctuations, emphasizing the importance of supply-side policies.

Conclusion

The analysis of the consumption function, its determinants, and the effects of shocks provides vital insights into macroeconomic stability and policy formulation. Understanding these relationships helps policymakers manage economic fluctuations and promote sustainable growth. The interplay between aggregate demand and supply with potential output and shocks underscores the complexity of macroeconomic management and the importance of targeted interventions.

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