Question

The table below depicts the consumption schedule for an economy. Assume there are no taxes in this economy. Disposable Income and Consumption Disposable Income (dollars) Consumption (dollars) $0 $25,000 10,000 30,000 20,000 35,000 30,000 40,000 40,000 45,000 50,000 50,000 60,000 55,000

Answer 1

B. Equilibrium consumption = 50000

C. The Marginal Propensity to Consume = 0.5, MPS = 0.5

c. Autonomous consumption = 25000

How to get the equilibrium

B] Equilibrium consumption refers to the consumption level at which consumption equals disposable income, in this case, reaching an equilibrium consumption of $50,000.

C] The Marginal Propensity to Consume (MPC) indicates the change in consumption resulting from a marginal change in income. Calculated as the change in consumption divided by the change in disposable income: (30,000-25,000)/(10,000-0)=0.5

The Marginal Propensity to Save (MPS) is the complementary portion of income not consumed, i.e., MPS=1-MPC. Therefore, MPS=1-0.5=0.5

Hence,

MPC = 0.5

MPS = 0.5

c) Autonomous consumption denotes the consumption level when disposable income is 0, amounting to an autonomous consumption of $25,000.

Answer 2

The consumption function demonstrates how consumption varies with changes in disposable income, using a formula involving marginal propensity to consume and autonomous spending. Tax influences reduce disposable income and change the slope of the consumption function, affecting consumption calculations.

Step-by-step explanation:

Understanding the Consumption Function

When examining the relationship between disposable income and consumption, one important concept is the consumption function. This function illustrates how consumption expenditures change with variations in disposable income. In an economy without taxes, the consumption function can be simply determined by applying a formula where consumption equals autonomous spending plus the product of marginal propensity to consume (MPC) and disposable income.

For example, with an MPC of 0.8 and autonomous consumption of $600, an income level of $20,000 would lead to:

Consumption = $600 + (0.8 × $20,000) = $600 + $16,000 = $16,600.

This formula changes when taxes are considered. Taxes reduce disposable income, which in turn lowers the slope of the consumption function due to a reduced marginal propensity to consume. An income of $20,000, with a tax rate of 30%, sees after-tax income of $14,000 and consequently:

Consumption = $600 + (0.8 × $14,000) = $600 + $11,200 = $11,800.

The consumption schedule reflects the changes in spending habits based on income, and it's evident that an increase in disposable income can lead to higher consumption levels, which was particularly notable following the tax cuts in February 1964.