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The economy is made up of C and I and is currently at full employment. If...

The economy is made up of C and I and is currently at full employment. If consumption is $5 trillion while savings is $1 trillion, what is current investment according to the Classical economists? Suppose consumption falls by $500 billion what will happen to savings and investment according to the classical economists?  

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Answer #1

According to classical economists saving=investment.Hence current investment =$1 trillion.

According to classical economics if consumption falls ,savings will increase and in turn it will cause interest rate to go down and hence people will start investing more.As a result total expenditure will remain same.According to them the economy is self correcting.

Now Y=C+I=6 Trillion.MPC=change in C/Change in Y=4.5/5.5=0.81.Hence MPS=1-0.81=0.19.We know multiplier=1/mps=5.26.Hence investment will be multiplied by this multipier value.

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