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    The consumption function

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    1. How would an increase in each of the following affect the consumption function? How would it affect the savings function? (a) net taxes (b) the interest rate (c)consumer optimism or confidence (d) the price level (e) consumers' net wealth (f) disposable income

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    Solution Preview

    The consumption function is a function that relates consumption to autonomous consumption and disposable income. In the general format it is given by,

    C = AC + MPC*DY,

    where, C is consumption, AC is autonomous consumption (consumption when income is zero), MPC is the marginal propensity to consume, and DY is the disposable income. Any change in AC, MPC, or DY will change the consumption function.

    a. Net Taxes: Net taxes is equal to Taxes - Transfer Payments. Also, disposable income is defined to be

    DY = Y - Taxes + Transfer Payments = Y - (Taxes - Transfer Payments) = Y - Net Taxes, where Y is total income.

    Hence, if net taxes go ...

    Solution Summary

    The consumption function is exemplified.

    $2.19