Suppose consumption function for an economy is C = 80 + 0.75 Y (where C = consumption function and Y = national income) and the investment expenditure is Rs. 200 crore. Estimate the following : (a) Equilibrium level of income (b) Values of consumption and saving at equilibrium level of income

Question

Accepted Answer

Given: C = 80 + 0.75Y, I₀ = ₹200 crore

(a) Equilibrium level of income:
At equilibrium, Y = C + I
Y = 80 + 0.75Y + 200
Y = 280 + 0.75Y
Y - 0.75Y = 280
0.25Y = 280
Y = 280 / 0.25
Y = ₹1,120 crore

(b) Consumption at equilibrium:
C = 80 + 0.75(1120)
C = 80 + 840
C = ₹920 crore

(c) Saving at equilibrium:
S = Y - C = 1120 - 920 = ₹200 crore
Or using S = I at equilibrium: S = ₹200 crore

(d) Investment Multiplier:
k = 1/(1-MPC) = 1/(1-0.75) = 1/0.25 = 4

The multiplier is 4, indicating that any change in investment will cause a 4-fold change in national income.