question archive The Keynesian model is for an open economy with a government sector
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The Keynesian model is for an open economy with a government sector.
4.4 Explain the marginal propensity to consume for this model by incorporating the provided information in your answer. (2)
4.5 Calculate the multiplier for this economy (3)
See explanation.
Step-by-step explanation
Aggregate consumption C is shown as:
C = Co + cYd, where
Co is autonomous consumption,
Yd is disposable income which is Y -Taxes
c is the marginal propensity to consume
The C function, is therefore, composed of two components---
autonomous ( not related to income) and induced ( related to income).
C increases as domestic income rises and falls if Y declines.
The marginal propensity to consume in graph, is shown by the slope of C function.
MPC = Change in consumption/Change in disposable income
MPS = marginal propensity to save = 1-MPC.
The expenditures multiplier = 1/(1-MPC).
Thus, if MPC = 0.75, multiplier = 1/(1-0.75) = 1/0.25 = 4.
That means that any expenditure like in I or G will create 4 of income or Y.
Higher the MPC, the bigger the multiplier.