Quiz 11: Expenditure Multipliers: the Keynesian Model


Marginal propensity to consume addresses a key economic issue: how much does the consumer spends out of her increased income which implies the proportion of additional income spent. From the data, see that income rose by $100 billion while consumption increased by $80 billion. Hence, MPC is 4/5 or 0.8. MPC in combination with MPS, the marginal propensity to save, together add up to 1. So if MPC is 0.8, MPS is necessarily 0.2. When income rises by $100 billion, only $80 billion of this increase is consumed. Hence, the rise in saving is $20 billion.

Autonomous expenditure refers to summation of investment and government expenditure. In addition, consumption expenditure might have an autonomous portion in it. In other words, we can say that autonomous expenditure is that expenditure which a country incurs when GDP is zero. It means autonomous expenditure is that part of the aggregate expenditure, which does not depend on GDP. The components of aggregate planned expenditure of Turtle Island are given below: img Here autonomous expenditure is $ 2 billion as it is the summation of investment and government expenditure. This is because, the autonomous consumption expenditure is zero here, and investment and government expenditure add up to $ 2 billion. We know that marginal propensity to consume can be obtained by dividing the change in consumption expenditure by change in the disposable income. img Where: • MPC=Marginal propensity to consume • img =Change in consumption expenditure • img Change in disposable income Now, substitute the values in the formula: img Here marginal propensity to consume is 0.60.

The components of aggregate planned expenditure of Turtle Island are given below: img a) Aggregate planned expenditure refers to the summation of expenditure on consumption, investment, and government expenses. From AE curve in the figure, we can get the aggregate planned expenditure corresponding to real GDP. Aggregate planned expenditure in case of GDP $ 6 billion is $ 5.6 billion. b) When the GDP is $ 4 billion then AE expenditure is more than that. It means inventories are falling which implies firms will increase its production. c) In case real GDP is $ 6 billion then aggregate planned expenditure is $ 5.6 billion. It means that, aggregate planned expenditure is lesser than the GDP and it implies that inventories are rising. Moreover, firms will in turn, decrease its production.