Question

"If households save more than firms invest, events will in time force households and firms to save and invest at the same rates." Evaluate and explain.

Answer 1

If households save more, it means they are consuming less. This means aggregate spending i.e. consumption+investment will be less than the level of output and current level of real income. Firms will experience unplanned inventory build up, so they will reduce output. As they produce less output now, their labor demand will decrease and this means unemployment will increase. However, it will also cause decline in potential output in the economy. Thus the economy becomes unstable and it eventually force the economy to become stable, which is at equilibrium Where savings and planned investment equals.