Consider an economy in which autonomous consumption, planned investment, government expenditure, autonomous taxes, and the marginal propensity to consume are given by: Ca = 1400, Ip = 1800, G = 1950, Ta = 1750, c = 0.6. – (a) What is the level of consumption when the level of income equals $10,000?
In macroeconomic analysis, understanding how different components of aggregate demand interact is crucial for grasping the dynamics of an economy. Let’s explore this through a practical example, where we analyze the level of consumption given certain economic parameters. Consider an economy with the following components:
- Autonomous consumption (Ca): $1400
- Planned investment (Ip): $1800
- Government expenditure (G): $1950
- Autonomous taxes (Ta): $1750
- Marginal propensity to consume (c): 0.6
Using these parameters, we can determine the level of consumption when the level of income (Y) equals $10,000.
Calculating Consumption
The consumption function in this context is given by:
C = Ca + c(Y – Ta)
Here:
- ( C ) is the total consumption.
- ( Ca ) is the autonomous consumption, the level of consumption when income is zero.
- ( c ) is the marginal propensity to consume, representing the fraction of additional income that is spent on consumption.
- ( Y ) is the level of income.
- ( Ta ) is the autonomous taxes, a fixed amount of taxes independent of the income level.
Given the parameters:
Ca = 1400
c = 0.6
Y = 10000
Ta = 1750
We can substitute these values into the consumption function:
C = 1400 + 0.6*(10000 – 1750)
First, calculate the disposable income (income after taxes):
Y – Ta = 10000 – 1750 = 8250
Next, calculate the marginal consumption (the part of the income that is spent):
0.6*8250 = 4950
Now, add the autonomous consumption:
C = 1400 + 4950 = 6350
Therefore, when the level of income equals $10,000, the level of consumption in this economy is $6350.
Economic Interpretation
This calculation provides valuable insight into the consumption behavior of the economy. Here’s a closer look at the components:
- Autonomous Consumption (Ca = 1400): This represents the baseline consumption level that occurs regardless of income. It is influenced by factors such as consumer confidence and access to credit.
- Marginal Propensity to Consume (c = 0.6): This indicates that for every additional dollar of disposable income, 60 cents are spent on consumption. A higher marginal propensity to consume suggests that households are more likely to spend additional income rather than save it.
- Disposable Income (Y – Ta = 8250): This is the income available to households after paying taxes. It is crucial because it determines the actual spending capacity of consumers.
In this simplified model, consumption is a primary driver of aggregate demand. The calculated consumption level of $6350 at an income level of $10,000 underscores the role of disposable income and the propensity to consume in shaping economic activity.
Broader Implications
Understanding the components and calculation of consumption helps policymakers and economists predict how changes in income, taxes, or consumer behavior might impact overall economic activity. For instance:
- Fiscal Policy: Changes in government spending (G) or taxes (Ta) can directly influence disposable income and, consequently, consumption. For example, a tax cut would increase disposable income, leading to higher consumption and potentially stimulating economic growth.
- Economic Stimulus: During economic downturns, measures to boost autonomous consumption or investment can help offset declines in income and maintain aggregate demand.
By analyzing such scenarios, economists can better formulate policies to stabilize or stimulate the economy, ensuring sustainable growth and development.