Question

QUESTION 20 Figure: Aggregate Expenditures I Planned aggregate spending (blllions of dollars) $575 500 425 312.50 500 Real GDP billions of dollars) in the diagram above, the marginal propensity to consume equals

Answer 1

Answer 20

AE = C + I + G ------------------------(1)

where AE = Aggregate expenditure, C = Consumption, I = investment and G = Government spending.

In simple macro model we assume I and G to be autonomous i.e. constant and independent of Y

Marginal Propensity to consume(MPC) is given by :

$MPC = \frac{\Delta C}{\Delta Y}$

Thus, Using (1) we have :

$\frac{\Delta AE}{\Delta Y} = \frac{\Delta (C + I + G)}{\Delta Y} = \frac{\Delta C}{\Delta Y} + \frac{\Delta I}{\Delta Y} + \frac{\Delta G}{\Delta Y}$

As I and G are assumed to be autonomous i.e. constant and independent of Y we have

$\frac{\Delta I}{\Delta Y}= 0 , \frac{\Delta G}{\Delta Y} = 0$

$=> \frac{\Delta AE}{\Delta Y}=\frac{\Delta C}{\Delta Y} = MPC$

Here we have two combination of Y are AE are (Y,AE) = (300,425) and (500,500

Hence,

$\frac{\Delta AE}{\Delta Y}= \frac{500 - 425}{500 - 300} = 0.375$

Thus,

$MPC = \frac{\Delta C}{\Delta Y } = \frac{\Delta AE}{\Delta Y}= \frac{500 - 425}{500 - 300} = 0.375$

Hence, Marginal Propensity to consume = 0.375