ECON 102 Lecture Notes - Lecture 27: Consumption Function, Tax Rate

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9 Dec 2020

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So as income rises, consumption expenditure also rises (but not by as much as the rise in income) by an amount dependent on the marginal propensity to consume (c). Now we are looking at a two-sector economy so y = c + i. And in such an economy income can be used, or disposed of, only by consuming or saving it. Actual saving (s) = actual investment (i) Investment is an example of an injection into the circular flow of income. Later we will allow for additional injections being government expenditure (g) and saving is a leakage from the circular flow of income. Also we will introduce additional uses of income or leakages, being taxation (t) and imports (m). Injection is aggregate expenditure not dependent on current income (i (bar)) Leakage is current income not devoted to current expenditure (savings) Injection = investment (i), government expenditure (g), exports (x) Leakages = saving (s), taxation (t), imports (m)

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1. Consider an economy in which all taxes are autonomous and the following values of autonomous consumption, planned investment, government expenditure, autonomous taxes, and the marginal propensity to consume are given: Ca=1,400 Ip=1,800 G=1,900 Ta=1,750 c=0.6

a. What is the level of consumption when the level of income (Y) equals $10,000?
b. What is the level of saving when the level of income (Y) equals $10,000?
c. What is the level of planned investment when the level of income (Y) equals $10,000? What is the level of actual investment? What is the level of unintended inventory investment?
d. Show that injections equal leakages when income (Y) equals $10,000.
e. Is the economy in equilibrium when income (Y)=$10,000? If not, what is the equilibrium level of income described in this question?
f. Is there a surplus or deficit in the government budget at the equilibrium level of income? How much?

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Question 1 Gross domestic product (GDP) measures the economy's production of

A) final goods and services.

B) intermediate goods.

C) consumer goods and services.

D) capital goods.

Question 2 Because GDP is measured in dollars per year, GDP is called a

A) stock.

B) flow.

C) cycle.

D) chain.

Question 3 Which of the following would not be included in the gross private domestic investment (I) category of GDP?

A) A retailer's additions to its inventories.

B) A bakery's purchase of a new oven.

C) A trader's purchase on NASDAQ stocks.

D) Newly built residential construction.

Question 4 Which of the following government payments would be included in the government consumption expenditures and gross investment (G) category of GDP?

A) A firefighter's monthly paycheck.

B) A retired grandmother's Social Security check.

C) A retired colonel's veteran's benefits.

D) A laid-off auto worker's unemployment conpensation check.

Question 5 The largest component in the income approach to measuring GDP is

A) compensation of employees.

B) rents.

C) profits.

D) net interest.

Question 6 Which approach to calculating GDP attempts to measure employee compensation, rents, profits, and net interest?

A) The circular-flow approach.

B) The product-market approach.

C) The income approach.

D) The expenditure approach.

Question 7 In recent years, people have benefited from greater amounts of leisure time. This trend

A) has caused GDP to rise.

B) has caused GDP to fall.

C) made GDP fluctuate randomly.

D) is not accounted for in the GDP statistic.

Question 8 National income (NI) is calculated by adjusting GDP for

A) depreciation of capital.

B) investment and net exports.

C) Social Security insurance contributions and transfer payments.

D) corporate and personal income taxes.

Question 9 If an economy's real GDP has increased, we can conclude that the economy

A) is inflationary.

B) has increased its production.

C) suffers from recession.

D) needs a tax cut.

Question 10 In the circular flow model, investment, government spending, and exports are classified as

A) injections.

B) leakages.

C) transfers.

D) consumption expenditures.

5. Saving and net flows of capital and goods In a closed economy, saving and investment must be equal, but this is not the case in an open economy. In the following problem, you will explore how saving and investment are connected to the international flow of capital and goods in an economy. Before delving into the relationship between these various components of an economy, you will be asked to recall some relationships between aggregate variables that will be useful in your analysis. Recall the components that make up GDP. National income (Y) equals total expenditure on the economy's output of goods and services. Thus, where C = consumption, I = investment, G = government purchases, X = exports, M = imports, and NX = net exports: Y = Also, national saving is the income of the nation that is left after paying for . Therefore, national saving (S) is defined as: S = Rearranging the previous equation and solving for Y yields Y = . Plugging this into the original equation showing the various components of GDP results in the following relationship: S = This is equivalent to S = , since net exports must equal net capital outflow (NCO, also known as net foreign investment). Now suppose that a country is experiencing balanced trade. Determine the relationships between the entries in the following table, and enter these relationships using the following symbols: > (greater than), < (less than), or = (equal to). Outcomes of Balanced Trade Imports Exports 0 Net Exports Y C+I+G Investment Saving Net Capital Outflow 0

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ECON 102 Lecture Notes - Lecture 27: Consumption Function, Tax Rate

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