Economics 1B
ECS1601
Semester 1
Department of Economics
IMPORTANT INFORMATION:
This tutorial letter contains solutions to assignment 03
BARCODE
, SOLUTIONS TO ASSIGNMENT 03 QUESTIONS – SEMESTER 1, 2017
3.1 Only statement [5] is correct.
In section 17.1, it is explained that simple economies consist of three major economic flows, namely
income, spending and production. In the national accounts, total spending during any particular period is
also equal to total production and income.
3.2 Only statement [5] is correct.
As explained in box 17.2 (page 317 of the prescribed textbook), one of Keynes’ assumptions of a simple
economy is that aggregate demand (A) is the force which determines total production (Y). Therefore, in
Keynes’ simple economy, production adjusts to changes in spending.
3.3 Only statement [4] is correct.
The consumption function shows the level of consumption spending at each level of income. It shows
that households spend more as their total income increases. (Refer to section 17.3 on page 318 of the
prescribed textbook.)
3.4 Only statement [2] is correct.
In section 17.3, it is explained that when income increases, consumption increases but the increase in
consumption is less than the increase in income. This happens because households save some of their
income.
3.5 Only statement [3] is correct.
In section 17.4 (page 322 of the prescribed textbook), it is explained that consumption spending is the
largest component of total spending (which is why option 1 is incorrect), and investment spending is
more variable and less predictable than consumption spending (which is why option 2 is incorrect).
In making investment decisions, firms estimate the cost of capital goods (e.g. buildings, machinery and
equipment) and compare these costs to the amounts they expect to earn from investment. The
investment decision thus involves three important variables, namely the cost of capital goods, the
interest rate and the expected revenue to be earned from the capital goods (which is why option 4 is
incorrect). There in an inverse relationship between the interest rate and the expected return on
investment spending, ceteris paribus. This relationship is illustrated in figure 17-3. Option 5 is thus
incorrect.
3.6 Only statement [3] is correct.
As explained in section 17.3 (page 319 of the prescribed textbook), the MPC can never be greater than
one, since the additional amount used for consumption out of additional income can never exceed the
additional income. The marginal propensity to consume therefore lies somewhere between zero and
one. In symbols we can therefore write 0 < 𝑐 <1.
3.7 Only statement [2] is correct.
In the equation, C = 35 + 0.75(Y), 35 is the constant, which means that R35 constitute autonomous
consumption, that is consumption independent from the level of income. This can also be regarded as
the minimum level of consumption, which is financed from sources other than income, for example, from
past saving or credit. 0.75(Y) is the induced component. Induced consumption is expenditure by
households which is determined by the level of income. 0.75(Y) indicates that when income increase, ¾
of that income will be spent on consumption. (See section 17.4 on page 318 of the prescribed textbook.)
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ECS1601
Semester 1
Department of Economics
IMPORTANT INFORMATION:
This tutorial letter contains solutions to assignment 03
BARCODE
, SOLUTIONS TO ASSIGNMENT 03 QUESTIONS – SEMESTER 1, 2017
3.1 Only statement [5] is correct.
In section 17.1, it is explained that simple economies consist of three major economic flows, namely
income, spending and production. In the national accounts, total spending during any particular period is
also equal to total production and income.
3.2 Only statement [5] is correct.
As explained in box 17.2 (page 317 of the prescribed textbook), one of Keynes’ assumptions of a simple
economy is that aggregate demand (A) is the force which determines total production (Y). Therefore, in
Keynes’ simple economy, production adjusts to changes in spending.
3.3 Only statement [4] is correct.
The consumption function shows the level of consumption spending at each level of income. It shows
that households spend more as their total income increases. (Refer to section 17.3 on page 318 of the
prescribed textbook.)
3.4 Only statement [2] is correct.
In section 17.3, it is explained that when income increases, consumption increases but the increase in
consumption is less than the increase in income. This happens because households save some of their
income.
3.5 Only statement [3] is correct.
In section 17.4 (page 322 of the prescribed textbook), it is explained that consumption spending is the
largest component of total spending (which is why option 1 is incorrect), and investment spending is
more variable and less predictable than consumption spending (which is why option 2 is incorrect).
In making investment decisions, firms estimate the cost of capital goods (e.g. buildings, machinery and
equipment) and compare these costs to the amounts they expect to earn from investment. The
investment decision thus involves three important variables, namely the cost of capital goods, the
interest rate and the expected revenue to be earned from the capital goods (which is why option 4 is
incorrect). There in an inverse relationship between the interest rate and the expected return on
investment spending, ceteris paribus. This relationship is illustrated in figure 17-3. Option 5 is thus
incorrect.
3.6 Only statement [3] is correct.
As explained in section 17.3 (page 319 of the prescribed textbook), the MPC can never be greater than
one, since the additional amount used for consumption out of additional income can never exceed the
additional income. The marginal propensity to consume therefore lies somewhere between zero and
one. In symbols we can therefore write 0 < 𝑐 <1.
3.7 Only statement [2] is correct.
In the equation, C = 35 + 0.75(Y), 35 is the constant, which means that R35 constitute autonomous
consumption, that is consumption independent from the level of income. This can also be regarded as
the minimum level of consumption, which is financed from sources other than income, for example, from
past saving or credit. 0.75(Y) is the induced component. Induced consumption is expenditure by
households which is determined by the level of income. 0.75(Y) indicates that when income increase, ¾
of that income will be spent on consumption. (See section 17.4 on page 318 of the prescribed textbook.)
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