Question

4. In a simple economy (assume there are no taxes; thus, Y is disposable income), the consumption function is: C = 500+ 0.80Y. The current level of real GDP is $5000. At this level of real GDP, consumption will be $ $1000, consumption would increase by $ and savings will be $ If GDP were to increase by (Round your responses to the nearest dollar.) , and the average propensity to save is At a real GDP level of $5000, the average propensity to consume is (Round your answers to two decimal places.)

Answer 1

a) Current level of GDP (Y)= $5,000

Consumption function: C= 500+0.80Y

Consumption at current level of GDP = 500 + 0.80*5,000

= $4,500

Savings at current GDP = Y - consumption

=5,000 - 4,500

= $500

If GDP were to increase by $1,000, the consumption will increase by 0.8*1000 = $800 (0.8 is marginal propensity to consume i.e change in consumption when income changes by 1 unit)

b) Real GDP = $5,000

Average propensity to consume = consumption/GDP

=4500/5000

= 0.9

Average propensity to save = 500/5000

= 0.1

(Average propensity takes into account autonomous consumption as well while in marginal propensity the autonomous consumption cancels out as it is constant which get cancelled while calculating marginal consumption)