Question

1. Suppose that GDP (Y) is 5000. Consumption (C) is given by the equation

C = 1,200 + 0.3*(Y-T) – 50*r, where r is the real interest rate. Investment (I) is given by the equation I = 1,500 – 50*r. Taxes (T) are 1,000 and government spending (G) is 1,500. (26 points)

1. Using the concept of opportunity cost, explain why there is an inverse relationship between consumption and the real interest rate in the equation above.
2. What is the equilibrium value of C, I and r?
3. What are the values of private saving, public saving, and national saving?
4. Now, assume there is technological innovation that makes business want to invest ore. It raises the investment equation to I = 2,000 -50*r. What are the new equilibrium of C, I and r.
5. What are the new values of private saving, public saving, and national saving?

SHOW ALL WORK AND RATIONALE

Answer 1