Question

Question two a) Given the following information: S = - 400 +0.25 Y → saving function I = 200 - 100 r + Investment function t = 0.2 → Tax rate G = 100 + Government expenditure X = 10 + Exports = 150 + 0.06 Y M → Im port function ii) b) Explain why autonomous saving is negative (2 marks) Express interest rate in terms of income (5 marks) Briefly explain the absolute income hypothesis ( 3 marks)

Answer 1

a) Saving is Income minus consumption . So S = Y- C
Cosumption function through this equation comes out to be C = 400 + 0.75Y
There is autonomous consumpion of 400 even when income (Y) is 0 . There will be some kind of consumption present even without any income, this further translates to negative savings, Hence autonomous savings is negative

b)

elta Pg 480 +0.75Y Y IAX-M キ う Y 200-100 rt10-15o-aNY 100 560 t Y-a Y 560 -100 SC0 560 -つ46 Y 100

Y-0.2Y in the equation is the disposable income.

Y^d = Y - tY = Y - 0.2Y = 0.8Y . t is the tax rate  

c) Absolute Income Hypothesis developed by John Maynard Keynes states that consumption is determined by the absolute level of income. This creates the basic relationship between consumption and income which becomes the consumption function ( as one given in the question). Consumption will be a function of disposable income . As income will rise consumption will also rise but not the same rate. The rate of increase in consumption when income increases by 1 unit is the marginal propensity to consume(mpc).