Workshop_5_HW_Problems_and_Answers

Workshop_5_HW_Problems_and_Answers - Workshop 5 HW Problems...

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Workshop 5 HW Problems and Answers 1 1. Why is there a “two-way” link between consumption and GDP? Consumption is part of aggregate expenditure so an increase in consumption increases aggregate expenditure and hence increases GDP. Simultaneously GDP is equal to aggregate income so an increase in GDP increases disposable income and hence increases consumption. 1 2. How does an increase in disposable income affect the consumption function? An increase in expected future income? An increase in disposable income leads to a movement upward along the consumption function. An increase in expected future income shifts the consumption function upward. 1 3. If the consumption function shifts upward, what happens to the saving function? Why? If the consumption function shifts upward, the saving function shifts downward. The upward shift in the consumption function means that for each level of disposable income consumption increases. If consumption increases at each level of disposable income, saving necessarily must decrease. The decrease in saving at each level of disposable income means that the saving function shifts downward.
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