Assume the following Keynesian income-expenditure two-sector model:
AD = Cp + Ip
Cp = Co + c .Y
Ip = Io
where AD is aggregate demand; Cp is planned consumption; Ip is planned investment; Co is exogenous consumption; c is the marginal propensity to consume; Y is the level of income (and output); and Io is exogenous investment.
(a) What is the relationship between the ‘marginal propensity to consume’ and the ‘average propensity to consume’?
(b) What is equilibrium Y in terms of Co, c and Io?
(c) Derive the multiplier for a change in Io.
(d) What does this model assume about aggregate supply and the general price level?
(e) Represent this model in a 45◦ cross-diagram and illustrate the equilibrium level of income.
