Suppose that quarterly consumption in dollars (CONS) is a linear function of the amount of disposable income in dollars (YDISP) with a two-order lag:
CONSt = a0 + a1YDISPt + a2YDISPt-1 + a3YDISPt-2 + Ut
the lowercase t's and numbers are all underscored.
a. A macroeconomist estimates α1, α2 and α3 to be 0.3, 0.4 and 0.1, respectively. What is the estimated effect of a one-time increase of 1000 in YDISP on CONS in this quarter, and for the next 3 quarters following that (by “one-time increase”, we mean that in the next quarter, YDISP goes back down to its original level)?
b. What is the effect of a permanent increase in YDISP of 1000 on the long-run average of CONS?