Econimic Output

Economic Output – Ameer Zaharuddin 1. Discuss and explain what effect a reduction in the marginal propensity to consume has on the size of the multiplier.
Answer:
* C = c1 + c0 YD
Marginal propensity to consume, MPC= c1

* Where C = Consumption, c0 = intercept, YD = disposable income
When a reduction in marginal propensity to consume, consumer disposable income is low, consumer does not has additional dollar or ringgit to dispose, a degree of decrease in disposable income is likely to decrease in consumption. * Therefore income – YD (decreases) consumption – C (decreases) C (consumption)

Slope = c1
Consumption Function - C = c0 + c1YD
MPC = C YD

C
Multiplier = 1 = 1 1 – MPC 1 – c1 c0 YD Y (disposable income)

YD C MPCMultiplier
A reduction in marginal propensity to consume will cause a reduction in the multiplier. When firms increase production in response to some initial change in demand, households will increase their consumption by a smaller amount when the MPC decrease. So, the income – included change in demand will be decreasely smaller causing a smaller multiplier effect.

2. Use the ZZ-Y model to illustrate the effects of a reduction in consumer confidence on the economy. Also explain what effect this reduction in consumer confidence has on the economy. Answer:
Equilibrium in the goods market: * Production (Y) = Demands (Z) * Z(Demands) = C(consumption)+I(investment)+G(government expenditure) * C = c0+c1YD; * c0 = intercept; c1 = marginal propensity to consume; YD = disposable income * YD = Y – T(Tax) * Y = Z Y = C + I + G Y = c0+c1(Y-T) + I + G Y = c0+c1Y – c1T + I + G Y – c1Y = c0 – c1T + I + G Y (1-c1) = c0 – c1T + I + G Therefore, Y = 1 (c0 – c1T + I + G) Y (Production) 1 – c1 Z (Demand), Y (Production)
Equilibrium