Question

A researcher has time series data for aggregate consumption, C, and aggregate disposable personal income, Y, for a certain country. She establishes that the logarithms of both series are I(1) (integrated of order one) and she correctly hypothesizes that the long-run relationship between them may be represented as C t =λYt v t where λ is a constant and v t is a multiplicative disturbance term. It may be assumed that logv t is normally distributed with zero mean and constant variance.

Answer 1

The question concerns the macroeconomic analysis of the relationship between aggregate consumption and aggregate disposable income using time series data.

Step-by-step explanation:

The question relates to the field of macroeconomics and examines the relationship between aggregate consumption and aggregate disposable personal income within a country, using time series data. The researcher uses a model where consumption (C) at time (t) is proportional to disposable personal income (Y) at time (t), with a multiplicative disturbance term (vt).

This relationship is exploitable when the logarithmic transformations of the data series show that they are integrated of order one (I(1)), which means they are non-stationary but can be made stationary by taking their first differences.

In economic models such as the expenditure-output or Keynesian cross model, the level of national income and consumption are closely related, and adjustments in income due to taxes, government spending, investments, and net exports (exports minus imports) determine the aggregate expenditure, which in equilibrium equals the aggregate output or GDP.

The long-run behavior of the economy is often considered in terms of aggregate supply and aggregate demand, with changes in physical capital, human capital, and technology shifting potential GDP and influencing long-term economic growth.