Consumption Function & percent practice.docx - Practice Exercise Working with a consumption function Suppose the consumption function is as follows

# Consumption Function & percent practice.docx - Practice...

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Practice Exercise: Working with a consumption function Suppose the consumption function is as follows: C = a 1 Y d + a 2 WRE/S + a 3 CC Where all the a’s (the sensitivity parameters) are greater than zero. Initial conditions, let: a 1 = 0.75 a 2 = 0.02 a 3 = 0.3 WRE/S = 23,000 CC = 100 1. Solve for C in terms of Y d and graph the consumption function. 2. Let Y d = 1,500. Solve for the level of consumption and label as point A on your diagram. 3. Now suppose disposable income increases due to a tax cut (Uncle Sam is trying create jobs) to 1700 but at the same time, the stock market crashes so that WRE/S falls to 20,000 and along with it, consumer confidence (CC) falls to 90. Re-solve for C in terms of Y d . 4. Solve for the level of consumption given the change in part 3 and add to your diagram as point B. 5. Did the tax cut work in terms of preventing consumption from falling due to the fall in

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• Fall '10
• staff
• Macroeconomics, Consumption function, tax cut, 1552

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