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26 August, 06:44

Consider the closed (no exports or imports) Latverian economy in which the consumption function is C = 300 + 0.75DI (where DI = Y - T is Disposable Income) and investment (I) is always $900. Government purchases are fixed at $1,300, and net taxes are fixed at $1,200. The next four questions refer to this model.

What is the marginal propensity to consume in this problem?

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  1. 26 August, 07:09
    0
    0.66

    Explanation:

    Marginal propensity to consume is the proportion of disposable income that is spent on consumption

    Marginal propensity to consume = change in consumption / change in income = C / Y

    Gross domestic product (Y) is the sum of all final goods and services produced in an economy within a given period which is usually a year.

    In a closed economy, GDP = Consumption + Investment spending + Government Spending

    Y = 300 + 0.75 (Y - $1,200) + $900 + $1,300

    Y = 300 + 0.75Y - $900 + $900 + $1,300

    Collect like terms

    Y - 0.75Y = $1600

    0.25Y = $1600

    Y = $6400

    Substitute for Y in the consumption function : 300 + 0.75 (Y - $1,200)

    300 + 0.75 ($6400 - $1,200)

    300 + 0.75 ($5,200) = $4,200

    C = $4200

    Marginal propensity to consume = $4,200 / $6400 = 0.66
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