Question

When government purchases goes up without current increase in tax rate, it will increase the expected future tax rate, by which decrease the expected future income. as a result of which, desired consumption falls and desired savings goes up. <- this is my opinion based on what I read the book.

However, according to the formula , Savings = Y - C - G. when G goes up, it directly affect the S, ( decreases S), this is contradicting how I thought.

Can anyone explain this in detail?

Answer 1

Your opinion is correct,

What you need to know is there are two types of savings,

Public Savings and Private savings

Public Saving = T - G

Where T is taxes and G is government expenditure.

I.e. Public Savings is what government is savings, government sources of revenue is Taxes. When government expenditure is less than its revenue than there is fiscal surplus .And, When Government expenditure increases, public savings declines.

Private savings = Y - C - T

Where Y is income and C is consumption , T are taxes

According to your opinion (which is true ), consumption declines so private savings increases.

National Savings = public saving + private saving

= T - G + Y - C - T ( from above )

= Y - G - C

As, Public savings decreases more than increases in private savings, that is why national savings decreases. This is how savings decreases when government expenditure increases.