The consumption function, developed by John Maynard Keynes, captures one of the key relationships in economics. It expresses consumption as a function of disposable income, where disposable income is defined as income after taxes. The accompanying table shows a portion of average U.S. annual consumption and disposable income for the years 1985-2006. The complete data, labeled Consumption Function, can be found on the text website.
Consumption and Disposable Income, 1985-2006
|
Year
|
Consumption
|
Disposable Income
|
|
1985
|
$23,490
|
$22,887
|
|
1986
|
23,866
|
23,172
|
|
1
|
1
|
1
|
|
2006
|
48,398
|
58,101
|
In a report, use the sample information to:
1. Estimate and interpret the model: Consumption = ß 0 + ß1 Disposable Income + ε.
2. Indicate which assumption might be violated, given that the analysis uses time series data.
3. Use the runs test to determine whether the positive and negative residuals occur randomly at the 5% significance level.