Chapter 15, Problem 1P

To determine

(a)

To explain:

Whether an increase in the interest rate will cause decrease in consumption.

Answer to Problem 1P

The increase in interest rate will decrease the consumption power in the economy.

Explanation of Solution

An increase in the interest rate increases the monthly payments made to buy automobiles, furniture as the consumer has to pay high instalment for goods bought on credit. As the disposable income of an individual remains the same and the interest rate is high, it leads to reduction in the consumption of goods and services.

Economics Concept Introduction

Consumption:

It refers to the goods and services that are consumed by the people in an economy.

Interest rate:

It is the rate at which the principal amount is charged for a specific time period. An amount is charged at this rate from the lender for the use of assets.

To determine

(b)

To explain:

Whether an increase in the value of stock market portfolio will cause decrease in consumption.

Answer to Problem 1P

An increase in the value of the stock market of the portfolio, will increase the consumption.

Explanation of Solution

The change in the consumption is shown below:

In the above figure,x-axis represents disposable income while the y-axis represents the consumption expenditure. The larger the amount of real wealth (including stock portfolio, property) larger will be the consumption power. $C_2$ represents the increase in consumption with an increase in real wealth. at point D whereas consumption will fall with a decrease in the value of real wealth.

Economics Concept Introduction

Consumption:

It refers to the goods and services that are consumed by people in the economy.

Stock market portfolio:

It refers to the numberof financial assets that is kept by an investor in the form of bonds, commodities, and mutual funds.

To determine

(c)

To explain:

Whether a decrease in disposable income will cause decrease in consumption.

Answer to Problem 1P

The reduction in disposable income will decrease the consumption.

Explanation of Solution

The decrease in disposable income will lead to decrease in consumption, as it is the remaining amount after filling income tax that can be used by an individual for consuming goods and services. If the disposable income decreases, it will have a direct impact on the consumption power of an individual.

Economics Concept Introduction

Consumption:

It refers to the goods and services that are consumed by people in the economy.

Disposable income:

It refers to that amount of income which is available in the household for savings as well as spending after income taxes.

To determine

(d)

To explain:

Whether an increase in income taxes will cause decrease in consumption.

Answer to Problem 1P

An increase in income taxes will decrease consumption.

Explanation of Solution

An increase in income taxes will decrease the amount of income left for consumption. As less amount is left with an individual, it will decrease the spending.

Economics Concept Introduction

Consumption:

It refers to the goods and services that are consumed by people in the economy.

Income Tax:

It refers to the tax levied by the government of a country on an individual's business. It acts as a source of revenue for the government. This amount is used in providing facilities to the citizens of the country.

To determine

(e)

To explain:

Whether deflation will cause decrease in consumption.

Answer to Problem 1P

The deflation will cause an increase in consumption.

Explanation of Solution

The disposable income of a household remains the same but due to deflation, it will increase the value of the currency, which will, in turn, lead to an increase in the purchasing power of the consumer. The same amount of money will be able to buy more goods and services. Hence, the consumption will increase.

Economics Concept Introduction

Consumption:

It refers to the goods and services that are consumed by people in the economy.

Deflation:

It refers to the fall in the prices of goods and services in an economy due to fall in inflation. The deflation leads to an increase in the purchasing power of the currency.