Chapter 11, Problem 1TY

To determine

To describe:The marginal propensity to consume, multiplier, equilibrium GDP if government purchases were reduced by $60 and the price level remain unchanged

Answer to Problem 1TY

The results showed that if 75% of the income is consumed, then its multiplier effect on income will be 4%.Since, the multiplier effect on consumption is 4, the reduction in government purchases by $60 will reduce the consumption expenditure by $240.

Explanation of Solution

In table (2), the GDP of an economy equals to consumption expenditure when both are at $1,720; hence the equilibrium level of GDP is $1,720

In figure (1) , GDP is measured on horizontal axis and consumption expenditure is measured on vertical axis

  

Graphical representation of equilibrium level of GDP

Figure 1 indicates that the consumption expenditure and GDP obtain equilibrium at E₁ when both values are at $1,720 and intersects the 45 degree line.

The increase in personal consumption per increase in additional amount of disposable income is described by the marginal propensity to consume (MPC).

The marginal propensity to consume can be calculated using the following formula:

$MPC=\frac{\Delta C}{\Delta DI}\mathrm{.....}(1)$

The following table presents the marginal propensity to consume using the formula in equation (1)

Table- 3

DI	C	ΔDI	Δ C	MPC
960	720	-	-	-
1080	810	120	90	0.75
1200	900	120	90	0.75
1320	990	120	90	0.75
1440	1080	120	90	0.75

Fifth column of table 1 shows the marginal propensity to consume is $0.75.

The consumption multiplier can be calculated using the following formula:

Using equation (2) calculate the multiplier:

$\begin{array}{l}Multiplier=\frac{1}{1-0.75}\\ =\frac{1}{0.25}\\ =4.00\end{array}$

The results showed that if 75% of the income is consumed, then its multiplier effect on income will be 4%.

Since the multiplier effect on consumption is 4, the reduction in government purchases by $60 will reduce the consumption expenditure by $240.

Economics Concept Introduction

Introduction:The balance yield of an economy is the degree of yield at which the aggregate sum of planned spending is simply equivalent to that of output, or GDP. That isequilibrium GDP = C + Ig. Consumption expenditures rise with GDP while arranged gross speculation expenditures are autonomous of the degree of GDP.