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Q. Assume that we have a expenditure function of the form C = 220 + 0.9×Yp, where Yp is permanent disposable income. Suppose that consumers estimate their permanent disposable income by a simple average of disposable income in the present and previous years: Yp== 0.5×(Yd + Yd-1), where Yd is actual disposable income. a. Suppose that disposable income Yd is equal to $4,000 in year 1 and is also equal to $4,000 in year 2. Illustrate the consumption in year 2? b. Suppose that disposable income increases to $5,000 in year 3 and then remains at $5,000 in all future years. What is consumption in years 3 and 4 and all remaining years? Illustrate why expenditure responds way it does to an increase in income. c. Illustrate the short-run marginal propensity to consume? What is the long -run marginal propensity to consume? d. Explain why this formulation of consumption may provide a more accurate description of consumption than the simple consumption function that depends only on current income.
Suppose now that the government reduces (t) and increases (t') so that the government budget constraint continues to hold. What will be the effects on an individual con-sumer's consumptionin present
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