Question

Suppose that C 5 a 1 bY, where C 5 consumption, a 5 consumption at zero income, b 5 slope, and Y 5 income. LO1.8 a. Are C and Y positively related or are they negatively related? b. If graphed, would the curve for this equation slope upward or slope downward? c. Are the variables C and Y inversely related or directly related? d. What is the value of C if a 5 10, b 5 0.50, and Y 5 200? e. What is the value of Y if C 5 100, a 5 10, and b 5 0.25?

Answer 1

Consumption & Income are directly related, consumption function is upward sloping.

Part 1) c = 110 ; Part 2) y = 360

Explanation:

Consumption Function shows the relationship between income & consumption level.

c = a + by ; where c = consumption , y = income , a = autonomous consumption at 0 income, b = change in consumption with change in income (marginal propensity to consume MPC)

Consumption 'c' is positively (directly) related to income 'y', as denoted by positive MPC 'b' . Higher income implies higher consumption, lower income implies lower consumption.

As 'c' & 'y' are positively correlated, the graph is upward sloping.

• c = a + by

If a = 10 , b = 0.5 , y = 200 :- c = 10 + 0.5 (200) = 10 + 100

c = 110

If c = 100 , a = 10 , b = 0.25 :- 100 = 10 + 0.25 (y) → 90 = 0.25y

y = 90 x 0.25 , y = 360