Assume the following Keynesian income-expenditure two-sector model: AD = C p + I p C p = C o + c .

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.

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