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The diagram depicts a consumption function of an economy, where C is the aggregate consumption spending, Y is the current income of the economy and c0 is the fixed (or autonomous) consumption such that c0 > 0. Assume that households that are not credit-constrained would completely smooth their consumption. Which of the following statements is correct?
A. If all households were not credit-constrained, and all income changes were perceived temporary, then the aggregate consumption line would be horizontal.
B. In times of credit crunch when the banks become less willing to lend, the aggregate consumption line would become flatter.
C. If a higher proportion of households have "weakness of will", then the aggregate consumption line would be flatter.
D. If the current income falls to zero, there will be zero consumption.
Feedback:In a credit crunch more households would become credit- constrained. Therefore the line would become steeper.
“Weakness of will” means that when there is an expected fall in the income, the households are less likely to adjust their consumption ahead of the fall, in order to build up some savings so that they can smooth consumption. In this case their marginal propensity to consume would be higher, implying a steeper aggregate consumption line.
c0 > 0 means that even if the current income is zero, the households will consume a strictly positive amount.
Question 2 of 15
0.0/ 1.0 Points
If the multiplier during a recession is equal to 2, then if the government wants to increase GDP by $500 billion it should increase spending by:
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