Q8) Define consumption and saving along with their schedules.

Also discuss the determinants of

consumption and saving.

Consumption

The consumption schedule or curve shows how much households plan to consume at various levels of
disposable income at a specific point in time.

Assuming there is no change in the nonincome determinants of consumption, namely, wealth, the price
level, expectations, indebtedness, and taxes. A change in disposable income causes movement along a
given consumption curve. A change in a nonincome determinant causes the entire schedule or curve to
shift.

Graph of schedule

Saving

The saving schedule or curve shows how much households plan to save at various levels of disposable
income at a specific point in time.

Assuming there is no change in the nonincome determinants of saving, namely, wealth, the price level,
expectations, indebtedness, and taxes. A change in disposable income causes movement along a given
saving curve. A change in a nonincome determinant causes the entire schedule or curve to shift.

Graph of schedule

Q9. Explain the relationship between investment and interest rate.

Higher interest rates reduce investment because higher rates increase the cost of borrowing and require
investment to have a higher rate of return to be profitable.

With higher rates, it is more expensive to borrow money from a bank. Saving money in a bank gives a
higher rate of return. Therefore, using savings to finance investment has an opportunity cost of
lower interest payments.

If interest rates are raised, firms will need to gain a better rate of return to justify the cost of
borrowing/using savings. Assuming inflation is zero, and interest rates are 5%. Then any investment
project would need an expected rate of return of at least greater than 5%. If interest rates were 7%,
then any investment project would need an expected rate of return of at least greater than
7%, and therefore less investment would occur.
 10. Explain the theory, arithmetic and rationale behind the multiplier model.

Theory
Multiplier model theory states that the economy will flourish as the government spends. According to
the theory, the net effect is greater than the dollar amount spent by the government.

Arithmetic
Multiplier = 1 / (1−MPC)

Rationale
The multiplier effect shows the increase in final income arising from any new injection of spending.

Q11. What is the government spending multiplier? Give an example

Spending Multiplier

The spending multiplier, or fiscal multiplier, is an economic measure of the effect that a change in
government spending and investment has on the Gross Domestic Product of a country.

For example, say that a national government enacts a $1 billion fiscal stimulus and that its consumers'
marginal propensity to consume (MPC) is 0.75. Consumers who receive the initial $1 billion will save
$250 million and spend $750 million, effectively initiating another, smaller round of stimulus. The
recipients of that $750 million will spend $562.5 million, and so on.

Q12. What are the functions of money? Discuss motives for demand for money

Functions of Money

Money plays an important role in an economy and thereby it performs several functions
The important functions performed by Money are:

1. Money as a Medium of Exchange - Money can be exchanged for goods and services and allow trade.
2. Money as a Store of value - Money can be used as a store of value for future needs and also make
future payments.
3. Money as a Measure of Value - Money allows a measure of price for each good and service which
can be compared to each other.
4. Money as a Standard of Deferred Payments - Money can be used to make future payments.
Example loans.

Motives for demand for money

There are three major kinds of demand for money:

1. Transaction Demand for Money - As per the quantity theory of money, the
transaction demand for money is a function of income and price, given the
 circulation velocity remains stable. So, if there is a rise in income, it will lead to a
rise in the demand for money.
2. Precautionary Motive - Money might be needed for unexpected expenditures or
emergencies (like medical, car repair, etc.) in the future. So, the demand for
money is based on payments that are needed immediately; hence people need
to hold on to money to be able to do that.
3. Speculative Motive - Money is a form of asset, and like any asset, its demand
depends on the rate of return and opportunity cost. The speculative motive for
demanding money comes into play in scenarios when holding money is less risky
than using it to lend it or invest in any other asset. For example, if someone
speculates the stock market to crash, they would sell their stocks to hold on to
money since the stock values are going to decrease and give them losses.