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Suppose a negative exogenous consumption shock affects the economy. In which of the following cases, the economic recession will be stronger in the short run? 2. a. The propensity to consume is 60% (of the disposable income) b. The propensity to consume is 75% (of the disposable income) Motivate your answer considering the goods market model. [5p]

Please answer and write clearly thanks a lot

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Answer #1

Solution: When there is negative exogenous consumption shock, the economic recession will be stronger in the short run if propensity to consume is higher. Hence, recession will be higher if propensity to consume is 75%.

This is because the value of multiplier = 1/(1-MPC). Hence, a negative consumption shock reduces the output more strongly if MPC is higher.

with mpo-7- 0.6 OV At with Above goods maket model shaws that when there 서 ve Consumption shock then decreases am mare OL than the case

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