Consumption Quiz

1. If policies were put into place to increase investment spending by $50 billion, what would be the potential effect on RGDP if mpc = .80? Explain.

If investment spending increased by $50 billion this would add to RGDP and initially raise it. If the marginal propensity to consume was 0.80, than approximately 80% of the additional dollars would be consumed by society, therefore increasing RGDP.

2. If disposable income remains stable, how can consumption change? Explain.

Consumption can still change even if disposable income remains stable because of the savings. If disposable income remains constant but people decide to save less of their income, then more of it can go towards consumption. For instance, in a simplified model where disposable income is $10 and one spends $8, then $2 is saved. But consumption can increase to $9 if that person only saves $1.

Inflation

How does unexpected inflation affect society?

Inflation, an increase in prices and the fall of the purchasing power of money, is an inevitable part of our economy. The value of inflation is not constant, and therefore varies each year. When the inflation rate is unexpected, people cannot prepare for its effects. Therefore, the unanticipated consequences hurt some people, but also help others. For example, when the inflation rate is unexpectedly high, loaners are hurt. When banks give fixed-rate loans, they expect the inflation rate to be a certain amount and factor that into the overall loan. But when the rate is actually higher, they end up losing money because the money they are repaid is worth less than they anticipated. The reverse is true for the borrowers of that money. Since the value of the money that they need to repay has actually decreased in value, they are spending less in order to pay off their debt so they gain from the situation. By the same token, in putting money away and saving it, it is actually hurting you, since over time this money will be worth way less because of unexpected inflation.