Question

Consider the following economy

Y = C + I + G

Y = 5,000

G = 1000

T = 1000

C= 250 + 0.75(Y-T)

I = 1000 – 50r

Compute private savings, public savings and national savings.

Find the equilibrium interest rate.

Suppose G rises to 1,250. Compute private savings, public savings, national savings and the interest rate. Explain intuitively why these variables have changed

Answer 1

Answer : As we know

Private saving =Y-C-T

Y =5000

C= 250+0.75(5000-1000)

C= 3250

T=1000

Private Saving = Y-C-T

Private saving = 5000-3250-1000 =750

Public saving = T-G = 1000-1000 =0

National Saving = public saving + private saving = 750+0 = 750

Equiliburm interest rate

Y =C+I+G

5000 = 3250 + 1000-50r+1000

50r = 250

r= 5

When G =1250

Y = C+I+G

Y =3250+ 750+1250 = 5250

Private savings = 5250-3250-1000

Private savings = 1000

Public saving =T-G = 1000-1250 = -250

National saving = private saving + public saving = 1000-250 =750

As government spending has been increased national savings remain the same as a result the public saving become negative where as private saving has been increased and the government faced budget deficit.