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Question: Answer the following questions.
1) Assume the following values: Marginal Propensity to Consume (MPC) b = 0.8; Autonomous Consumption a = 250; Investment Spending I = 500. There is no government spending at this point.
a) For a consumption function C = a + bY, what is the equilibrium value for income Y in the economy (Y = C + I, here)? (1)
b) What is the value of Y if Investment Spending increases to 750? (0.5)
c) What can you observe in the change in Y that follows changes in I? How is the effect called that is apparent in your results? (1)
d) If you add the government sector, with expenditure G = 250, what is the new equilibrium income? (For I = 750) (0.5)
2) What happens when the Marginal Propensity to Save (MPS) is reduced? How does equilibrium output change? (1)
3) Use the MPS to explain the ‘paradox of thrift'. (1)
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