MODULE: MACROECONOMICS BB106

Unit 3: Consumption and Investment

TUTORIAL 3

Short-answer Problems
1) Differentiate between the average propensity to consume and the marginal propensity to consume.
2) What are the marginal propensity to consume (MPC) and marginal propensity to save (MPS)? How
are the two concepts related? How are the two concepts related to the consumption and saving
functions?
3) Which is the most volatile component of total spending? What four factors contribute to the
volatility of this component of total spending?
4) Calculate the multiplier when the MPC is 0.5, 0.75, 0.90. What is the relationship between MPC and
the multiplier?
5) Calculate the multiplier when the MPS is 0.5, 0.25, 0.10. What is the relationship between MPS and
the multiplier?
6) Complete the accompanying table.
Level of output
and income
(GDP = DI)
Consumption

Saving

APC

APS

MPC

MPS

$480

$_____

$8

_____

_____

_____

_____

520

_____

_____

_____

_____

_____

560

_____

_____

_____

_____

_____

600

_____

16

_____

_____

_____

_____

640

_____

24

_____

_____

_____

_____

680

_____

32

_____

_____

_____

_____

720

_____

40

_____

_____

_____

_____

760

_____

48

_____

_____

_____

_____

800

_____

56

_____

_____

_____

_____

(a) Using the below graphs, show the consumption and saving schedules graphically.
(b) Locate the break-even level of income. How is it possible for households to dissave at very low
income levels?

7. Suppose a familys annual disposable income is $8000 of which it saves $2000.

(a) What is their APC?
(b) If income rises to $10,000 and they plan to save $2800, what are MPS and MPC?

True / False Questions

1) Consumption equals disposable income plus saving.
2) If DI is $275 billion and the APC is 0.8, we can conclude that saving is $55 billion.
3) The average propensity to consume is defined as income divided by consumption.
4) 1 + MPS = MPC.
5)

If marginal propensity to consume is 0.70, then it will necessarily consume seven-tenths of its total
income.

6) The slope of the consumption schedule is measured by the MPC.

7) Investment is highly stable; it rarely changes.
8) The greater the MPC, the greater the multiplier.
9) If the MPS is 1, the multiplier will be 1.
10) If the MPC is 0.9 and investment spending increases by $20 billion, real GDP will increase by $200
billion.

Multi-Choice Questions
1. John Maynard Keynes created the aggregate expenditures model based primarily on what historical
event?
A. Bank panic of 1907
B. Great Depression
C. Spectacular economic growth during World War II
D. Economic expansion of the 1920s
2. If Carol's disposable income increases from $1,200 to $1,700 and her level of saving increases from
minus $100 to a plus $100, her marginal propensity to:
A. save is three-fifths.
B. consume is one-half.
C. consume is three-fifths.
D. consume is one-sixth.

3. Refer to the figure above. The consumption schedule indicates that:

A. consumers will maximize their satisfaction where the consumption schedule and 45 line intersect.
B. up to a point consumption exceeds income, but then falls below income.
C. the MPC falls as income increases.
D. households consume as much as they earn.
4 Investment spending in the United States tends to be unstable because:
A. expected profits are highly variable.
B. capital goods are durable.
C. innovation occurs at an irregular pace.
D. all of these contribute to the instability.

5. The multiplier effect means that:

A. consumption is typically several times as large as saving.
B. a change in consumption can cause a larger increase in investment.
C. an increase in investment can cause GDP to change by a larger amount.
D. a decline in the MPC can cause GDP to rise by several times that amount.
6. The multiplier is defined as:
A. 1-MPS.
B. change in GDP initial change in spending.
C. change in GDP/initial change in spending.
D. change in GDP - initial change in spending.
7. If the MPC is .70 and investment increases by $3 billion, the equilibrium GDP will:
A. increase by $10 billion.
B. increase by $2.10 billion.
C. decrease by $4.29 billion.
D. increase by $4.29 billion.
8. The increase in income that results from an increase in investment spending would be greater the:
A. smaller the MPS.
B. smaller the APC.
C. larger the MPS.
D. smaller the MPC.
9. If the MPC is 0.8, what change in investment is required to reduce income by $60 billion?
A. $12 billion
B. $15 billion
C. $20 billion
D. $25 billion
10. In a closed, private economy, income is $50 billion and consumption is $40 billion. When income
rises by 10 percent, consumption rises by 9 percent. The MPS over the relevant income range is:
A. 0.11 and the multiplier is 9.09
B. 0.28 and the multiplier is 3.57
C. 0.62 and the multiplier is 1.61
D. 0.72 and the multiplier is 3.57

Answer the next question(s) on the basis of the following table that illustrates the multiplier process.

11. Refer to the above table. The marginal propensity to consume is:
A. .5
B. .75
C. .8
D. .9
12. Refer to the above table. The marginal propensity to save is:
A. .1
B. .20
C. .25
D. .3
13. Refer to the above table. The change in income in round two will be:
A. $0.94
B. $2.81
C. $3.75
D. $4.00
14. Refer to the above table. The total change in income resulting from the initial change in investment
will be:
A. $5
B. $10
C. $15
D. $20
15. Refer to the above table. The total change in consumption resulting from the initial change in
investment will be:
A. $5
B. $10
C. $15
D. $20

16. Refer to the above table. The multiplier in this economy is:
A. 2
B. 3
C. 4
D. 5