Reference no: EM13396239

Suppose the consumption function is as follows:

C = ^­­   a₁ Y_d + a₂ WRE/S  + a₃CC

Where all the a's (the sensitivity parameters) are greater than zero.

Initial conditions: Let a₁ = 0.60, a₂ = 0.04,

a₃ = .5, WRE/S = 18,000: CC = 90

a) Solve for C in terms of Y_d  and graph the consumption function.

b)  Let Y_d = 2000.... solve for the level of consumption and label as point A on your diagram.

c) Now suppose disposable income falls due to a tax increase (Uncle Sam is trying to balance the budget) to 1800 but at the same time, the stock market rallies so that WRE/S rises to 22,000 and along with it, consumer confidence (CC) rises to 100. Re-solve for C in terms of Y_d.

d) Solve for the level of consumption given the change in part c) and add to your diagram as point B.

e) Now show as point C, the level of consumption that would have occurred if Uncle Sam did not raise taxes (we still had the same change WRE/S and CC as in part c)).

f) What is the percent change in consumption from points A to B?