Practice with APC, APS, MPC and MPS

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1 Practice with APC, APS, MPC and MPS Part A Average Propensities The average propensity to consume (APC) is the ratio of consumption expenditures (C) to disposable income (DI), or APC =C / DI. The average propensity to save (APS) is the ratio of savings (5) to disposable income) or APS =S / DI. 1. Using the data in Figure 20.1, calculate the APC and APS at each level of disposable income given. The first calculation is completed as an example. II Figure 20.1 Average Propensities to Consume and to Save Income Consumption Saving APe APS $0 $2,000 -$2, ,000 3,600-1, ,000 5,200-1,200 6,000 6, ,000 8, ,000 10,000 12,000 11, How can savings be negative? Explain. PartB Marginal Propensities The marginal propensity to consume (MPC).is the change in consumption divided by the change in disposable income. It is a fraction of any change in DI that is spent on consumer goods: MPC =dc / WI. The marginal propensity to save (MPS) is the fraction saved of any change in disposable income. The MPS is equal to the change in saving divided by the change in DI: MPS =~S / ddi. 3. Using the data in Figure 20.2, calculate the MPC and MPS at each level of disposable income. The first calculation is completed as an example. (This is not a typical consumption function. Its purpose is to provide practice in calculating MPC and MP5.) Activity written by John lv'lorton, National Council on Economic Education, New York, N.Y., and James Spellicy, Lowell High School, San Francisco, Calif. Advanced Placement Economics?\1acroeconomics: Student Activities ~ National Council on Economic Education. NewYor~ N.Y. 111

2 II Figure 20.2 Marginal Propensities to Consume and to Save Income Consumption Saving MPC MPS $12,000 $12,100 -$ ,000 13, ,000 13, ,000 14, ,000 15,100 '900 17,000 15,600 1, Why must the sum of MPC and MPS always equal I? Parte II Figure 20.3 Changes in APe and MPC as DI Increases Income Cqnsumption Savings APe APS MPC MPS... $10,000 $12,000 -$2, ,000 21,000-1,000 30,000 30,000 a 40,000 39,000 1,000 50,000 48,000 2,000 60,000 57,000 3,000 70,000 66,000 s. Complete Figure 20.3, and answer the questions based on the completed table. 6. What is the APC at a DI level of $10~OOO? At $20,OOO? _ 7. What happens to the APe as DI rises? _ 8. What is the MPC as DI goes from $50,000 to $60,OOO? From $60,000 to $70,000? _ 9. What happens to MPC as income rises? What happens to MPS as income rises? _ 10. \Vhat is the conceptual difference between APC and MPC? 112 Advanced Placement Economics ~1acroeconomics: Student Activities National Council on Economic Education, New Yor~ N.Y.

3 4. Suppose you are given the follo\ving inforlnation about Macroland~ where Y is real GDP~ T is taxes, and C is consulnption spending. Year y T c a. Fill in the following table using the inforlnation in the table. Year Income b. What is the MPC for this economy? c. What is the MPS for this economy? d. What is the value of the multiplier for this economy?

4 Problems and Exercises 1. Consider an economy that is initially in long-run equilibrium as drawn in the following graph where LRAS is the long-run AS curve, AD 1 is the aggregate demand curve, SRAS 1 is the short-run AS curve, Yl is potential output, and Pl is the equilibrium aggregate price level. Aggregate price Level LRAS Aggregate output a. Draw a graph using the AS-AD model to illustrate the effect of each of the following separate changes to the model in the short run. 1) The economy's central bank decreases the money supply. 2) Productivity decreases in the economy. 3) Consumer confidence in the economy increases. 4) Commodity prices fall dramatically. b. Identify verbally what happens to aggregate output and the aggregate price level relative to the initial long-run equilibrium for each of the scenarios. c. For each of the scenarios determine whether the economy faces a short-run recessionary gap or an inflationary gap. d. For each of the scenarios deternline if there is an active stabilization policy that will offset the particular shock. If so, discuss what this active stabilization policy is. You may find it helpful to draw a graph illustrating the effects of your active policy prescription on the aggregate economy.

5 e. For each of the scenarios identify what happens in the long run to the aggregate price level and the aggregate output level if there is no active stabilization policy. 2. Consider an economy operating with an inflationary gap in the short fun. Briefly describe what this short-run equilibrium looks like, making specific reference to potential output and then describe the process by which this economy moves from short-run to long-run macroeconomic equilibrium. Use a graph to illustrate your description. 3. Consider an economy operating with a recessionary gap in the short-run. a. Why does this represent a problem for this economy? Draw a graph illustrating your answer. b. What policies are available to policymakers to address this problem? Draw graphs illustrating possible policies. c. If policymakers do nothing, describe the mechanism by which this economy will return to long-run macroeconomic equilibrium. Draw a graph illustrating this long-run adjustment. 21

3. Explain what the APS tells us about people s spending and saving habits.

3. Explain what the APS tells us about people s spending and saving habits. National Income and Price Determination Reading Guide Chapters 9, 10 and 11 Chapter 9: Building the Aggregate Expenditures Model Objective... 1. Explain how the consumption schedule helps us find equilibrium