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Homework answers / question archive / a) Write brief notes on the following economic theories, illustrate and give examples where necessary i) The permanent income hypothesis ii) Keynesian consumption function iii) Liquidity preference theory b) Given that the money supply is 1400, consumption equation is represented as c= 120 + 0
a) Write brief notes on the following economic theories, illustrate and give examples where necessary
i) The permanent income hypothesis
ii) Keynesian consumption function
iii) Liquidity preference theory
b) Given that the money supply is 1400,
consumption equation is represented as c= 120 + 0.7 (Y-T),
investment equation is I=200-10r, where r is the real interest rate
while Taxes (T) and Government expenditure are 200 and 400 respectively.
The real money demand function is expressed as m/p=0.1y -100r (units in million)
i) Solve for equilibrium real output and equilibrium interest rate (6marks)
ii) Assume that autonomous investment increases by 300, compute the investment multiplier and analyze the new impact on income and consumption.
c) The ministry of finance is keen in ensuring that vision 2030 is realized.
Discuss some of the key projects that you believe can move the economy towards this target
The permanent income hypothesis: The permanent income hypothesis, a consumption theory propounded by Milton Friedman, suggests that the consumption pattern of a consumer depends on his permanent income. According to this theory, there are two parts of personel income, which includes permanent income and transitory income.
Y =Yp +YT
The consumer forms is consumer decisions based upon his permanent income, while the transitory income mainly goes as savings or some extra benefir consumptions.
ii) Keyensian consumption function : The Keyensian consumption function, as propounded by John Meynard keyenes, is a consumption function , that shows the functional relationship between total consumption and gross national income. It is a upward sloping curve with a slope less than the 45 degree line. It has a positive intercept along the consumption axis. It is written in the form
C= a + bY (a = positive intercept, b = marginal propensity to consume)
iii) Liquidity Preference Theory: The demand for money is called the liquidity preference. The theory was propounded by John Maynard Keynes. According to this theory, there are three main motives behing the demand for money or liquidity preference. These are the a) transactionary demand for mney, b) seculative demand for money and c) precautionary demand for money. The money demand function or the liquidity prefeerence curve is a downward sloping curve showuing negative relationsip between rate of interest and money demanded.
b) The following informations are provided:
c= 120 + 0.7 (Y-T),[ The consumtion function]
I=200-10r,[ Investment function]
m/p=0.1y -100r [ money demand function]
Money supply = 1400
Taxes (T) = 200
Gvernment expenditure (G)= 400
The condiion of equilibrium in the goods market is
Y = C+I+G
Putting the provided values the equation becomes:
Y = 120 + 0.7 (Y-T)+ 200-10r + 400
Y = 720 + 0.7( Y- 200) -10 r
Y= 720 + 0.7Y - 140 -10r
0.3Y = 580 - 10r ........(i)
Y = 1933.34 - 33.34r
The equilibrium in the money market occurs when, Money demand= Money supply
0.1y -100r= 1400
0.1Y = 1400 +100r .......(ii)
Solving equation i and ii, we get
r= 12.48% and Y= 26480
please see the attached file.
