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Unformatted text preview: Macro Questions (Quiz 2) 1. What is the consumption function? What drives the functions of marginal propensity to consume, marginal propensity to save, average propensity to consume, and average propensity to save. If we know this, we will be able to predict instead of simply observe the behaviors of consumers. The consumption function tells us what consumers will be willing to spend at certain levels of income. The equation of the consumption function is consumption = autonomous in- come + marginal propensity to consume * disposable income. You can find disposable income by subtracting taxes from your gross income. Your autonomous income is the debt you have from over spending at a certain income level. Keyne’s knew that people don’t simply spend what they make, most people have the tendency to go over their cur- rent income in spending and dipping into their future income as well. Future income can be determined by expectation for the future, such as a raise or job promotion. Wealth effects are also taken into account when considering future income. Suppose your stock holdings go up in value, then you believe you will have more money to spend in the future, whether this is true or not. People can over-spend with credit but changes in interest rates might change the way people think about credit. The last factor in future income is taxes. Taxes are what determine how much or your gross income you can spend as your disposable income, so if there are large tax cuts, you will have more money to spend than you did before. When people spend more than they make, they have debt and autonomous income that has to be put into the consumption function equation as a. 2. What is the significance of the 45 degree line that is often included in the con- sumption function? On the 45 degree line, you are consuming exactly what your disposable income is. But not everyone can be so perfect and most people don’t act this way, they over-spend or dissave. If you are dissaving, but then get a raise after a while on the same job, you will cross the 45 degree line and be able to save. At the point where you cross, you are breaking even and consuming the exact amount that you are obtaining from your in- come. 45 degrees is half of 90 degrees, which is the whole graph s it makes sense that you would be spending exactly what you earn and break-even on this line. When you are consuming more than you are saving, the consumption function will be above the 45 degree line and when you are saving more than you are consuming the consumption function will be below the 45 degree line. 3. What is the primary factor affecting the level of consumption? How can the simple consumption function be represented algebraically? Show what role the marginal propensity to consume plays in a simple linear function....
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This note was uploaded on 11/17/2011 for the course EC 251 taught by Professor Abid during the Summer '10 term at Grand Rapids Community College.
- Summer '10
- Marginal Propensity To Consume