consumption function

Question 1

what is the equation that shows the connection between AE, O and Y?

Answer 1

O=Y=AE

Question 2

what is the consumption function model based upon?

Answer 2

the relationship between the level of disposable income received by households and the level of consumption and savings

Question 3

what is the equation for the simple consumption function?

Answer 3

Y=C+S

Question 4

what does the 45 degree line represent?

Answer 4

it shows all points where planned expenditure is equal to planned income.

Question 5

why is the 45 degree line drawn?

Answer 5

to show all the points of equilibrum, along this line output is always equal to expenditure

Question 6

what does equilibrum mean?

Answer 6

the level of income, output and spending in the economy is in balance

Question 7

what does the break even amount mean?

Answer 7

where all income is spent on consumption and nothing is saved

Question 8

when is savings positive?

Answer 8

at higher levels of income because C is less than the income

Question 9

when is savings negative?

Answer 9

at lower levels of income when C exceeds income

Question 10

what is the general formula?

Answer 10

c=a+bY

Question 11

what does a stand for?

Answer 11

autonomous consumption (when Y=0)

Question 12

what does b stand for?

Answer 12

MPC

Question 13

what is the MPC?

Answer 13

marginal propensity to consume - the fraction of any change in income that is spent on consumption

Question 14

how is MPC calculated?

Answer 14

change in C / change in Y

Question 15

how is MPS calculated?

Answer 15

it is whatever is not consumed

Question 16

what is the savings function equation?

Answer 16

S=a+(1-b)Y

Question 17

what does a stand for in the savings function?

Answer 17

the amount of savings required to be spent to fund consumption when Y=)

Question 18

what does (1-b) stand for?

Answer 18

1-MPC or MPS and is the slope of the SF

Question 19

what is dissaving?

Answer 19

when Y is not great enough to fund C you are spending your savings

Question 20

when will S cross the x axis?

Answer 20

when C=Y at the break even point when C intersects the 45 degree line

Question 21

what is the APC?

Answer 21

the overall proportion of Y that has been consumed at a particular level of Y

Question 22

what is the APC equation?

Answer 22

APC=C/Y

Question 23

why does the APC fall as income rises?

Answer 23

because as Y rises autonomous consumption represents a smaller and smaller proportion of your Y

Question 24

what is APS?

Answer 24

the overall proportion of Y that has been saved at a particular level of Y

Question 25

what is the APS equation?

Answer 25

APS=S/Y

Question 26

why does APS rise when Y rises?

Answer 26

savings begins to represent a larger proportion of Y

Question 27

what are the assumptions when the financial sector is added?

Answer 27

• levels of investment are constant across all levels of Y
• the level of AE must now be equal to consumption plus investment so AE=C+I
• C rises by the level of I
• equilibrum occurs where S and I intersect

Question 28

what is the equilibrum level of income called?

Answer 28

Ye

Question 29

what happens if the level of income is either above or below the equilibrum level?

Answer 29

planned spending will not equal output and firms inventories will change, signalling them to either increase or decrease production. the economy will move towards equilibrum

Question 30

when income is greater then equilibrum and output is greater then aggregate expenditure how will the economy move to equilibrum?

Answer 30

• firms experience a surplus
• inventories rise
• firms cut production and employment
• output falls, income falls, expenditure falls
• continue until Ye

Question 31

when income is below equilibrum, investment exceeds savings and expenditure is greater than output how will the economy move towards Ye?

Answer 31

• shortage of goods
• inventories fall
• firms increase production and employment
• output and income rise
• continue until Ye