Question

Given the following consumption schedule and investment schedule:

7. Given the following consumption schedule and investment schedule $4000 $5250 8000 9200 11400 11910 14300 14520 12 10 08 05 500 750 1000 1375 8850 9930 Determine the specific linear equation for each function. Do not round numbers Find the numerical value of break-even income (YB), and equilibrium income (Ye). Assume that i .04 Explain and show the multiplier effect of an interest rate change to .03

Answer 1

For every 4000 increase in income consumption rises by 8850 - 5250 = 3600. Hence MPC = 3600/4000 = 0.9.

Now when Y is 4000, C is 5250. This implies 5250 = C0 + 0.9*4000 or C0 = 1650. Thus, consumption function is

given by C = 1650 + 0.9Y

For every 0.01 or 1% decline in interest rate, investment rises by (1375 - 1000)/(8 - 5) = 125. Hence the

investment will be 2000 for an interest rate of 0%. This gives the investment function I = 2000 - 125r.

Break even income YB = C or Y = 1650 + 0.9Y. This gives YB = 16500.

Equilibrium income Ye = C + I or Y = 1650 + 0.9Y + 2000 - 125*4 or Ye = 31500

Now we have Y = 1650 + 0.9Y + 2000 - 125r or Y = 36500 - 1250r,

When interest rate falls to 3%, income changes to 36500 - 1250*3 =  32750