Question

Suppose the consumption function is \(C=\$ 200+\) \(0.8 Y\). a. What is the amount of autonomous consumption? b. What is the marginal propensity to consume? c. What would consumption equal when real GDP cquals \(\$ 1,000\) ?

Short answer

a. The amount of autonomous consumption is $200. b. The marginal propensity to consume (MPC) is 0.8. c. Consumption when real GDP is $1,000 is $1,000.

Step-by-step solution

Identify the autonomous consumption

In the consumption function C = \(200 + 0.8Y\), the autonomous consumption is the constant term, which is \(\$200\). This means that the amount of autonomous consumption is \(\$200\) regardless of income.

Identify the marginal propensity to consume

The marginal propensity to consume (MPC) is the coefficient of the income variable (Y) in the consumption function. In our case, the MPC is \(0.8\). This means that for every additional \(1\) of income, consumption will increase by \(0.8\).

Calculate consumption when real GDP is \(1,000\)

To calculate consumption when real GDP is \(\$1,000\), replace the income variable (Y) with \(1,000\) in the consumption function: C = \(200 + 0.8(1,000)\) C = \(200 + 800\) Therefore, consumption equals \(\$1,000\) when real GDP is \(\$1,000\).

Key concepts

Autonomous Consumption

Understanding the concept of autonomous consumption is fundamental in the study of economics, particularly when examining consumer behavior. Autonomous consumption, also referred to as the intercept of the consumption function, represents the level of consumption that occurs regardless of the household’s income. In simpler terms, it's the spending that people must do to cover their basic needs such as food and shelter, even if their income falls to zero.

To delve deeper, let's consider the consumption function provided in the exercise: \(C = 200 + 0.8Y\). In this case, \(200\) represents the autonomous consumption. It's the amount consumers will spend even in the absence of income. This expenditure is vital because it supports the basic welfare of individuals and can be supported by savings, borrowing, or wealth previously accumulated.

It's included in economic models to help understand and predict total consumption. It's also a key component in determining the multiplier effect, which describes how an increase in economic activity can lead to a more than proportionate increase in national income.

Marginal Propensity to Consume

The Marginal Propensity to Consume (MPC) is a cornerstone concept in macroeconomics that informs us about consumer spending habits. MPC is essentially the fraction of additional income that a household consumes rather than saves. It is calculated by taking the change in consumption over the change in income.

In the given consumption function, the MPC is represented by the coefficient \(0.8\), which stands next to the income variable (Y). This indicates that for every additional dollar earned, consumers will spend 80 cents and save the remaining 20 cents. The value of MPC is always between 0 and 1, as people will typically spend only a part of their additional income. The MPC plays a critical role in fiscal policy since higher MPC values suggest that changes in income will significantly influence consumption, which in turn affects economic growth.

Real GDP

Real Gross Domestic Product (GDP) is a vital economic indicator that measures the value of all goods and services produced over a specific time period, adjusted for inflation, providing a more accurate representation of an economy's size and how it's changing over time.

In practical terms, when we talk about consumption being equal to \(1,000\) when real GDP is \(1,000\), it's illustrating a scenario where the entire economic output is consumed. Normally, consumption is a large part of GDP, but it’s rare for them to be equal as GDP also includes investment, government spending, and net exports. Understanding real GDP helps policymakers and businesses make informed decisions, as it reflects the true purchasing power of an economy and guides monetary and fiscal policies.

Macroeconomics

Macroeconomics is the branch of economics concerned with the performance and structure of an economy as a whole. It encompasses the analysis of economy-wide phenomena, including inflation, unemployment, and economic growth. Concepts such as the consumption function, autonomous consumption, and the marginal propensity to consume are integral parts of macroeconomic analysis.

These concepts help economists and policymakers predict how economic policies, like changes in taxes or government spending, will impact overall consumption and economic health. Macroeconomic theories and models are used to simulate and try to predict the behavior of the whole economy, aiming for stability and growth. Macroeconomics stands in contrast to microeconomics, which focuses on individual markets and the behavior of consumers and firms.