Question

I. Suppose the United States economy is represented by the following equations: Z = C + I + G C = 300 + 0.9YD T = 1,000 I = 200 YD = Y – T G = 2,000

a. Calculate the equilibrium level of output.

b. After you have calculated equilibrium income, calculate the level of consumption at this level of output. (Hint: Since you know the level of taxes and income, you can easily obtain the level of disposable income to calculate consumption.)

c. Write out the saving function for this economy. Then, calculate the level of saving that occurs at the equilibrium level of output.

d. Now, suppose households decide to increase their autonomous saving by 100. Equivalently, households have decided to cut their autonomous consumption by 100. Calculate the new equilibrium level of output that occurs as a result of the decrease in autonomous consumption of 100. Has this increased desire to save had a positive or negative effect on economic activity? Explain.

e. Based on your analysis in part (d), calculate the level of saving that occurs at this new equilibrium level of output. Compare this level of saving with the level of saving obtained in part (c). What has happened to the level of saving in this economy as a result of the increased desire to save? f. What is the paradox of saving? Based on your answer in part (e), do you observe the paradox of saving in the short run? Explain.

g. Do you expect to observe the paradox of saving in the long run as well? Why or why not? Explain.

Answer 1