Question

Question 3 Consider a closed economy described by the following equations: Y-C+1+G Y -5,000 G- 1,000 T= 1,000 C 2500.75 (Y T) I 1,000-50*r (3 points) In this economy, compute private saving, public saving, and national saving. (2 points) Find the equilibrium interest rate. (2 points) Draw a graph containing the saving and investment curves for this economy. a. b. c. Show the financial market equilibrium d. (2 points) Now suppose the G rises to 1,250. Compute private saving, public saving, and national saving. (2 points) Find the new equilibrium interest rate. (1 points) On a new graph, draw the investment curve and the new saving curve. Show e. f. the new equilibrium in the financial market

Answer 1

a) Private saving = Y - T - C = 5000 - 1000 - 250 - 0.75 (5000 - 1000) = 4000 - 250 - 0.75 (4000) = 4000 - 250 - 3000 = 750 Public saving = T - G = 1000 - 1000 = 0 National saving = Private saving + Public saving = 750 + 0 = 750 b) Equilibrium interest rate y = C + I + G 5000 = 250 + 0.75 (Y - T) + 1000 + 1000 - 50 r = 250 + 0.75 (5000 - 1000) + 2000 - 50 r 3000 = 250 + 3000 - 50 r 50 r = 250 r = 5 c) We can graph investment and saving like a demand and supply graph. Investment = demand component Savings = supply component where Investment = savings, we determine the equilibrium rate of interest \r\n Equilibrium is at E where I = S at r If investment spending charges, the investment curve will shift upwards and a new equilibrium will be attained at point E.