The diagram depicts a consumption function of an economy, where C is the aggregate consumption spending, Y is the current income of the economy and c0 is the fixed (or autonomous) consumption such that c0 > 0. Assume that households that are not credit-constrained would completely smooth their consumption. Which of the following statements is correct?

A. If all households were not credit-constrained, and all income changes were perceived temporary, then the aggregate consumption line would be horizontal. B. In times of credit crunch when the banks become less willing to lend, the aggregate consumption line would become flatter. C. If a higher proportion of households have “weakness of will”, then the aggregate consumption line would be flatter.

D. If the current income falls to zero, there will be zero consumption.

If the multiplier during a recession is equal to 2, then if the government wants to increase GDP by $500 billion it should increase spending by:

A. $100 billion. B. $200 billion. C. $250 billion D. $1 trillion

Assuming that there is no government spending or trade, an economyâs aggregate demand is given by its domestic consumption C and investment I, AD = C + I = c0 + c1Y + I.

In the economyâs goods market equilibrium this equals its output: AD = Y. Solving for Y this yields:

Y = [1/(1-c1)] (c0+ I)

Given this equation, which of the following statements is correct?

A.

The multiplier is given by 1 â c1.

B.

The boost in the economyâs output is the same whether the aggregate demand shock comes from an increase in investment I or in autonomous consumption c0.

C.

The larger the marginal propensity to consume c1, the smaller the multiplier.

D.

If c1 = 1/3, then a £1 million increase in investment would result in a £2 million increase in the output.

Assume that in France and Germany, it is not possible for a household to increase its borrowing based on an increase in the market value of their house. In addition, a large down-payment (as a per cent of the house price) is required for house purchase. On the basis of this information, which of the following statements is correct when there is a rise in the house price?

A. There is a positive financial accelerator effect for the existing homeowners who are credit-constrained. B. Would-be homeowners would increase saving, leading to their reduced consumption. C. A rise in the house price leads to an increase in human capital. D. A rise in the house price is likely to lead to an increase in consumption in France and Germany.

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