30 Jun The diagram depicts a consumption function of an economy, discussion help All interaction on Studypool is 100% anonymous. Username has been c
The diagram depicts a consumption function of an economy, discussion help
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Question Description
The diagram depicts a consumption function of an economy, where C is the aggregate consumption spending, Y is the current income of the economy and c0 is the fixed (or autonomous) consumption such that c0 > 0. Assume that households that are not credit-constrained would completely smooth their consumption. Which of the following statements is correct?
A. If all households were not credit-constrained, and all income changes were perceived temporary, then the aggregate consumption line would be horizontal.
B. In times of credit crunch when the banks become less willing to lend, the aggregate consumption line would become flatter.
C. If a higher proportion of households have “weakness of will”, then the aggregate consumption line would be flatter.
D. If the current income falls to zero, there will be zero consumption.
Feedback: In a credit crunch more households would become credit- constrained. Therefore the line would become steeper.
“Weakness of will” means that when there is an expected fall in the income, the households are less likely to adjust their consumption ahead of the fall, in order to build up some savings so that they can smooth consumption. In this case their marginal propensity to consume would be higher, implying a steeper aggregate consumption line.
c0 > 0 means that even if the current income is zero, the households will consume a strictly positive amount.
Question 2 of 15
0.0/ 1.0 Points
If the multiplier during a recession is equal to 2, then if the government wants to increase GDP by $500 billion it should increase spending by:
A. $100 billion.
B. $200 billion.
C. $250 billion
D. $1 trillion
Feedback: The multiplier increases the initial spending by the government (or consumers or businesses) by increasing spending and therefore income in the economy.
Question 3 of 15
0.0/ 1.0 Points
Assuming that there is no government spending or trade, an economy’s aggregate demand is given by its domestic consumption C and investment I, AD = C + I = c0 + c1Y + I.
In the economy’s goods market equilibrium this equals its output: AD = Y. Solving for Y this yields:
Y = [1/(1-c1)] (c0+ I)
Given this equation, which of the following statements is correct?
A.
The multiplier is given by 1 – c1.
B.
The boost in the economy’s output is the same whether the aggregate demand shock comes from an increase in investment I or in autonomous consumption c0.
C.
The larger the marginal propensity to consume c1, the smaller the multiplier.
D.
If c1 = 1/3, then a £1 million increase in investment would result in a £2 million increase in the output.
Feedback:
The multiplier is given by 1 / (1 – c1).
Larger c1 means smaller 1 – c1, which in turn means larger multiplier 1 / (1 – c1).
When c1 = 1/3 then 1 / (1 – c1) = 1.5, and therefore a £1 million increase in I would result in a 1.5 million increase in Y.
Question 4 of 15
1.0/ 1.0 Points
Assume that in France and Germany, it is not possible for a household to increase its borrowing based on an increase in the market value of their house. In addition, a large down-payment (as a per cent of the house price) is required for house purchase. On the basis of this information, which of the following statements is correct when there is a rise in the house price?
A. There is a positive financial accelerator effect for the existing homeowners who are credit-constrained.
B. Would-be homeowners would increase saving, leading to their reduced consumption.
C. A rise in the house price leads to an increase in human capital.
D. A rise in the house price is likely to lead to an increase in consumption in France and Germany.
Feedback: Correct
Question 5 of 15
1.0/ 1.0 Points
In the US and the UK, loans are widely available based on a rise in home equity. Additionally, unlike in France and Germany where large downpayments (as a percentage of the house price) are required, in the US and the UK only small downpayments are required for house purchases. On the basis of this information, which of the following statements is correct for the US and the UK when there is a rise in the house price?
A. There is a positive financial accelerator effect for the existing homeowners who are credit-constrained.
B. There would be no effect on the consumption of the existing homeowners who are not credit-constrained.
C. Would-be homeowners would increase saving and reduce their consumption more than they would in France and Germany.
D. A rise in house price is likely to dampen consumption in the US and the UK.
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