Question

Set Six

Some economists argue as follows:

Suppose that Y=Y* currently. An increased rate of saving from income (a lower rate of consumption) reduces interest rates by raising the supply of savings that can be borrowed. Investors borrow the extra savings, and investment rises to replace the decline in consumption. Y remains at Y*.

Evaluate this argument. [Limit 80 words: 4 marks]

Answer:

Answer 1

The rise in savings rate will reduce the consumption level among the consumers. This increasing savings level will reduce the interest rate and enhance the level of production through increasing rate of investment. The investors were willing to purchase the savings at this low level of interest rate. This higher investment increases the level of production and increase the consumption pattern through higher wage rates. The rising trend of production will increase the demand for labour and the wage rate. Thus the higher wage rate improves the living condition of the people and increase the consumption pattern also. The real output will be same as the natural rate of output.