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- Generalised q-Theory of Investment, Fiscal Policy and Consumption with Credit-Constrained Consumers

- Macro & Microeconomics
- Assignment
- Masters
- Pages: 8 (2000 words)
- September 11, 2020

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The paper “ Generalised q-Theory of Investment, Fiscal Policy and Consumption with Credit-Constrained Consumers” is a forceful variant of the assignment on macro & microeconomics. We there add equation 3 and 4 to have The economy`s aggregate consumption C1 = +, Thus derived the economy`s aggregate consumption is C1 = + C1 = - + Let us assume t be 1 C1 = - + C1 = - + C1 = Derive an expression for the economy’ s marginal propensity to consume current disposable income, . C1 = + MPC = The equation shows that the marginal propensity to consume is greater than zero and there is an interest rate factor in the utility function.

This means when there is change in income, there is exact change in interest rate. The function also implies that income consumption decreases when one has reduced labour supply. Compare this expression with the value of the marginal propensity to consume in an economy with no credit-constrained consumers. Explain the difference. When consumers are credit-constrained, they are left with limited money to spend for consumption purposes. And with any decline in consumption, equilibrium level of income declines.

Here, initial equilibrium occurred at E0, at the intersection between the 45º Line and the C+I+G line i. e., at the intersection between the aggregate demand and aggregate supply. Initial equilibrium output was OY. However, with rise in the propensity to save, consumption level falls. Resultantly, new C+I+G line become C1+I+G. The new C1+I+G line intersect the 45º line at point E1. Equilibrium income also declines to OY1. Therefore, the rise in the marginal propensity to save actually reduces income as well as the total savings of the economy. Paradox of thrift using injections-withdrawals Initial equilibrium occurred at E, at OY level of output, at the intersection between savings and investment.

The initial equilibrium level of output is 0Y0. Now, with the rise in propensity to save, S+T line shifts upwards to S2+T and new equilibrium is set at point E1 and at a lower level of output OY1. And, as output level declines, total savings of the economy is reduced. So, with the rise in the marginal propensity to save, actual savings declines. This is indeed paradoxical in nature and was termed as paradox of thrift by Keynes. (Boyes and Melvin, 2006, p.

248) uppose now that the government enacts a debt-financed reduction of current taxes T1 by one unit, without cutting current or planned future public consumption. Assume further that the government and the private sector have the same planning horizons, and that the private sector understands that the tax cut today will have to be matched by a tax hike tomorrow of the same present value, due to the intertemporal government budget constraint. In other words, suppose that all consumers realised that: + = 0 Consumers will try to attain the highest level of total utility possible, given their budget constraints.

This consumer can maximize total utility, subject to the budget constraint. Consumer optimum is achieved when the marginal rate of substituting is just equal to the feasible, or realistic, rate of exchange between leisure and other consumption. This realistic rate is the ratio of the two prices of goods involved. It is represented by the absolute value of the value of the budget constraint, the rate at which the consumer wishes to substitute is just equal to the rate which the consumer can substitute.

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