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“Keynesian” problems Formulas Consumption = autonomous consumption plus the product of the additional amount of consumption per dollar of income and disposable income Consumption Function: C= a + MPC (Y) Marginal Propensity to Consume: additional amount of consumption per dollar of income Marginal Propensity to Save = the additional amount of savings per dollar of income earned
“Keynesian” problems
Formulas
Consumption = autonomous consumption plus the product of the additional amount of consumption per dollar of income and disposable income
- Consumption Function: C= a + MPC (Y)
Marginal Propensity to Consume: additional amount of consumption per dollar of income
Marginal Propensity to Save = the additional amount of savings per dollar of income earned.
- 1-MPC
Spending Multiplier:
- If the MPC reads .65, and autonomous consumption is 100 billion with disposable income of 300 billion, what is the value of the consumption function?
- If autonomous consumption in the economy is (300) with the MPC at .75 and disposable income of 400 billion, what is the value of the savings function?
- What is the value of MPC when MPS is .84?
- If disposable income increases from 100 billion to 350 billion with a corresponding increase in consumption from 25 to 30 billion, what is the value of MPC?
- If MPC is .65 and the government injects 300 million in spending, how much consumption is created?
- Also, what if the govt. cut taxes by the same amount in #5, how much consumption is created? Hint: remember to read over the "Keynesian Mathematics" notes.
Expert Solution
1) MPC = 0.65
Autonomous consumption (a) = 100 billion
Disposable Income (c) = 300 billion
Consumption Function = a + MPC * c = 100 + 0.65 * 300 = 295
2) If autonomous consumption = 300, thus autonomous saving = -300
MPC = 0.75
MPS = 0.25
Saving function = Autonomous saving + MPS * Disposable Income = -300 + 0.25 * 400 = -200
3) MPC = 0.16 when MPS = 0.84 because MPC + MPS = 1
4) Disposable income income rises by 250
Consumption rises by 5
MPC = (Change in consumption / Change in disposable income) = (5 / 250) = 0.02
5) MPC = 0.65
Multiplier = [1 / (1 - MPC)] = [1 / (1 - 0.65)] = 2.86
Rise in consumption by 300 million raise aggregate demand by 300 * 2.86 = 857.14 million
6) Tax multiplier = (MPC / MPS) = (0.65 / 0.35) = 1.86
Tax cut by 300 million will raise consumption by 300 * 1.86 = 557.14 million
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