(A)Demonstrate Graphically and Explain the Implications of the Permanent Income

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The Answer is (a)The permanent income hypothesis suggests that consumers make spending decisions on the basis of lifetime income rather than current income.This means that,in terms of the multiplier model,the mpc = 0 and so the AE curve is horizontal.(b)This implies that the multiplier essentially does not exist (technically it would have the value of 1).To see this consider the diagram below:

(a)The permanent income hypothesis suggests that consumers make spending decisions on the basis of lifetime income rather than current income.This means that,in terms of the multiplier model,the mpc = 0 and so the AE curve is horizontal.(b)This implies that the multiplier essentially does not exist (technically it would have the value of 1).To see this consider the diagram below: We start at equilibrium point A on AE<sub>0</sub>.Now suppose there is some change in autonomous expenditures such that AE shifts up to AE<sub>1.</sub> The result is a move to equilibrium point B.Since the ΔE = ΔY we can see that the value of the multiplier is 1.

We start at equilibrium point A on AE₀.Now suppose there is some change in autonomous expenditures such that AE shifts up to AE_1. The result is a move to equilibrium point B.Since the ΔE = ΔY we can see that the value of the multiplier is 1.

(A)Demonstrate Graphically and Explain the Implications of the Permanent Income

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(A)Demonstrate Graphically and Explain the Implications of the Permanent Income

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Correct Answer:
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