Homework Answers
The vertical line is the saving function (S0), assumed independent of interest rate. Initial equilibrium is at point A with initial interest rate r0 and quantity of investment (and saving) I0.
(a) Increase in tax will decrease consumption and increase savings, shifting S0 rightward to S1, intersecting Id at point B with lower interest rate r1 and higher quantity of investment I1. Consumption, interest rate and output will fall.
(b) Decrease in private saving will shift S0 leftward to S1, intersecting Id at point B with higher interest rate r1 and lower quantity of investment I1. Consumption, interest rate and output will rise.
(c) Increase in money supply will decrease interest rate, which will increase the quantity of investment demanded. When r0 falls to r1, it intersects S0 at point C with amount of saving being constant at I0, but intersects Id at point B, with higher quantity of investment demanded being I1. There is a savings-investment imbalance equal to (I1 - I0). Consumption and output will rise.
(d) Decrease in investment demand will shift Id curve leftward to Id1, intersecting S0 at point B. Interest rate falls to r1 but quantity of investment remains the same at I0. Output and consumption will fall.
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