Question

Graphing the consumption function from the MPC Consider a hypothetical economy in which the marginal propensity to consume (MPC) is 0.75. That is, if disposable income increases by $1, consumption increases by 75 Suppose further that last year disposable income in the economy was $500 billion and consumption was $450 billion On the following graph, use the blue line (circle symbol) to plot this economy's consumption function based on these data On the following graph, use the blue line (circle symbol) to plot this economy's consumption function based on these data. 700 600 500 400 300 a 200 Z 100 -100 100 200 300 4500 600 700 800 DISPOSABLE INCOME (Billions of dollars) From the preceding data, you know that the level of saving in the economy last year was $ economy is billion and the marginal propensity to save in this Suppose that this year, disposable income is projected to be $700 billion. Based on your analysis, you would expect consumption to be sbillion and saving to be bilion

Answer 1

The consumption function reflects the relationship between consumption and national income, with an MPC of 0.75 implying a 75% consumption rate of any additional income. The MPS is 0.25 (1 - MPC), indicating 25% of additional income is saved. Calculations are made combining autonomous consumption with income multiplied by MPC for consumption, and the remainder for savings.

Step-by-step explanation:

The consumption function indicates how consumption expenditures increase with the rise in national income, showing an upward-sloping relationship. In the example given, with a marginal propensity to consume (MPC) of 0.75, each additional dollar of income results in 75 cents being spent on consumption. If the disposable income is $700 billion, we would calculate expected consumption by adding autonomous consumption, which is the consumption level if income were zero ($600 billion in this hypothetical), to the product of the MPC and the increase in disposable income (0.75 * $700 billion).

To find the saving, we use the marginal propensity to save (MPS), which is encapsulated in the equation MPC + MPS = 1, and therefore MPS is 1 - MPC. The savings can be calculated as the product of MPS and the increase in disposable income, plus or minus any existing wealth or debt from the autonomous consumption.

Finally, the level of savings last year when disposable income was $500 billion and consumption was $450 billion, would have been the remaining $50 billion ($500 billion - $450 billion). Following the same logic, if the disposable income rises to $700 billion, expected consumption would be the autonomous consumption plus $525 billion (0.75 * $700 billion), totaling $1125 billion. Savings would then be the remaining $175 billion ($700 billion - $525 billion).