Rationale for Modeling Wealth Shocks
An economy experiences a significant decline in housing values, leading households to increase their saving at every level of current income. Explain why this change in behavior is represented as a shift in the aggregate consumption function (a change in autonomous consumption) rather than a change in its slope (a change in the marginal propensity to consume).
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An economy experiences a sharp, unexpected decline in average house prices. In response, many households feel their overall wealth is now below their desired long-term level and decide to save more out of their current income to compensate. Within the standard aggregate consumption function, how is this behavioral change initially represented?
Analyzing a Housing Market Shock
In an economic model where consumption depends on disposable income, a widespread decline in house prices that prompts households to increase their saving is represented by a decrease in the marginal propensity to consume.
Modeling a Housing Market Downturn
Tracing the Effects of a Negative Wealth Shock
An aggregate consumption function is given by C = c₀ + c₁Yd, where c₀ is autonomous consumption, c₁ is the marginal propensity to consume, and Yd is disposable income. Match each economic event to its most direct impact on the components of this function.
An economy's aggregate consumption is initially described by the equation C = 200 + 0.75Yd, where C is total consumption and Yd is disposable income. A sudden and significant drop in national property values occurs, leading households to increase their rate of saving to rebuild their target wealth. This behavioral shift results in a $50 billion decrease in consumption spending that is independent of any change in current income. What is the new equation for the aggregate consumption function?
An economy experiences a significant and unexpected drop in housing prices. Arrange the following events in the correct logical sequence to show how this shock is transmitted through the economy and represented in the aggregate consumption model.
A country's central bank is forecasting the economic impact of a recent, sharp decline in national house prices. To accurately predict the magnitude of the initial downward shift in the aggregate consumption function, which of the following pieces of information would be most essential for the bank's analysts to consider?
Rationale for Modeling Wealth Shocks