CHAPTER 8
AGGREGATE DEMAND AND THE POWERFUL CONSUMER
TEST YOURSELF
2. In ordinary language, an investment is the purchase of any asset, irrespective of whether the asset is newly produced or used, or whether it is a real thing or a financial instrument. Economists restrict the term to the purchase of new, physical assets, including plant and equipment, inventory and housing. for an economist, investment is an increase in the capital stock.
(a) Investment.
(b) Not investment (financial asset, not physical).
(c) Not investment (previously produced asset, not new).
(d) Investment.
(e) Not investment (previously produced asset, not new).
4. As shown on Figure 6 in the text, the consumption function shifts down when the price level rises, from C0 to C2.
DISCUSSION QUESTIONS
3. When disposable income, that is, the sum of everyone’s income after they have paid their taxes, rises by $100, consumption expenditures rise by $90. Students may have quite different answers to the second part of this question. This may lead to an interesting discussion of the life cycle or permanent income hypothesis. The variation in student answers can also lead to an understanding that macroeconomists are interested primarily in aggregate or average behavior, where many individual idiosyncrasies have canceled out. Generally, an individual will have a higher MPC while in college and a somewhat lower MPC 25 years later.
5. A consumption function shows the aggregate consumer expenditures to be expected at different levels of disposable income. Since a tax reduction results in an increase in disposable income, economists can use the consumption function to predict the initial change in spending that will follow a tax cut.
6. People tend to base their consumption expenditures not just on their current income, but also on the level of income that they expect in the future. A temporary tax cut raises today’s disposable income but not expected future income, so consumers are not likely to change their expenditures as much as they would if they expected a permanent increase in disposable income.
7. If the tax incentives for savings had been successful, the consumption function would have shifted down. At each level of disposable income, people would have consumed less and saved more. The text argues, however, that there is no evidence to indicate that such incentives have had much of an effect on savings.