Answers to Assignment Five

Page 1: Income Level and Consumption

• Assignment Five Overview: Analyzing income levels, consumption, savings.

Table: Level of Output and Income (GDP = DI)

Analysis:

• (a) Break-Even Level of Income:

  • The break-even level of income is $125 where saving equals zero.

  • Households can dissaving (spending more than their income) through:

    • Borrowing.

    • Liquidating accumulated savings.

• (b) Understanding Constant MPC and MPS:

  • MPC and MPS represent the slopes of the consumption and savings schedules.

  • Though the proportion of income consumed decreases and the proportion saved increases, the scheduled slopes remain constant.

  • Only at the 45-degree line would APC and MPC be equal (i.e., slope equals 1).

Page 2: Population Income and Consumption

Table: Disposable Income and Consumption

Observations:

• At lowest income levels, households experience dissaving (spending exceeds income).

• As income increases, savings rise significantly, indicating:

  • Higher incomes enable greater savings.

  • Increased importance of savings with rising incomes.

Table: Continued Disposable Income

Page 3: Consumption and Saving

Table: Income Level and Saving

Investment Decisions:

• (a) Bookseller's Decision:

  • Investment cost: $3,000.

  • Expected profit: $4,000.

  • Current interest rate: 12%.

  • Conclusion: Yes, as profit exceeds cost by $1,000 (rate of return = 33.3%).

• (b) Baker's Decision:

  • Investment cost: $700.

  • Expected profit: $800.

  • Borrowing interest rate: 15%; real rate: 11%.

  • Conclusion: Yes, expected return of 14.3% exceeds adjusted cost (total return = 3.3%).

• (c) Mechanic's Decision:

  • Investment cost: $11,000.

  • Expected revenue: $12,000.

  • Lost returns from saving: $880 (8%).

  • Conclusion: No, total return only 1.01% after accounting for opportunity costs.

Page 4: Multiplier Calculations

Multiplier Based on MPC:

• Calculating the Multiplier:

  • When MPC = 0.5, => Multiplier = 2.

  • When MPC = 0.75, => Multiplier = 4.

  • When MPC = 0.90, => Multiplier = 10.

• Relationship:

  • Direct relationship; as MPC increases, the multiplier also increases.

  • Multiplier Formula: multiplier = 1 / (1 - MPC).

Multiplier Based on MPS:

• Calculating the Multiplier:

  • When MPS = 0.5, => Multiplier = 2.

  • When MPS = 0.25, => Multiplier = 4.

  • When MPS = 0.10, => Multiplier = 10.

• Relationship:

  • Inverse relationship; as MPS decreases, the multiplier increases.

  • Multiplier Formula: multiplier = 1 / MPS.