Question

Economists in Fundlandia, a closed economy, have collected the following information about GDP and public savings in their country:

Y = 1000
G = 100
T = 100

They further estimate that national savings and investment are governed by the following expressions:

S = 150 + 50*r
I = 600 - 100*r

Where r is the country's real interest rate in % terms (thus if you find r = 5, then r is 5%).

Problem Set #2 - Part II - 11.1 a.) Fundlandia is operating at potential output (GDP). Calculate the following equilibrium values for the country: The Real Interest Rate Investment Consumption Private Savings i.) The equilibrium real interest rate in Fundlandia is _____%. A. 1.5 B. 4.5 C. 3 D. 2 ii.) The equilibrium level of investment in Fundlandia is: A. 300 B. 500. C. 600 D. 400 iii.) The equilibrium level of consumption in Fundlandia is: A. 400. B. 300. C. 500 D. 600 iv.) The equilibrium level of private savings in Fundlandia is: A. 500 B. 300 C. 600 D. 400 b.) The government of Funlandia plans to increase government spending by 150 next year and finance this increase in G by issuing new government bonds. Which of the two functions below now describes national savings in Moldavia? S = 300 + 50*r S = 50*r i.) The function that now describes national savings in Moldavia is __________ because this increase in G has ________ public savings. A.  S = 300 + 50*r ; increased B. S = 50*r ;increased C. S = 50*r ; decreased D.  S = 300 + 50*r ; decreased Now calculate the new levels of investment and the real interest rate as a result of this policy change. Depict your answers both before and after the change in a well-labeled loanable funds diagram. [Use "A" for your original equilibrium point and "B" for your new equilibrium point after the policy change.] ii.) The new equilibrium real interest rate in Fundlandia is _____%. A. 4.5 B. 2 C. 5 D. 4 iii.) The new equilibrium level of investment in Fundlandia is: A. 500 B. 200 C. 400 D. 300 c.) Does equilibrium investment in the country change by more or less than the change in government spending? Why? Explain by calculating the policy change's effect on private savings. i.) This change in government policy has __________ private savings to _______. A. Increased ; 400 B. Decreased ; 200 C. Decreased ; 300 D. Increased ; 350 ii.) As a result of this change in government policy, equilibrium investment changes by ________ than the change in government spending because its effect on private savings __________ the crowding out effect. A.  More ; exacerbates B.  More ; mitigates C. Less ; exacerbates D. Less ; mitigates d.) What prediction would economists make for the behavior of potential GDP growth as a result of the policy change in (b)? Explain. i.) Economists would predict that this policy change would _______ potential GDP growth, because the ________ in investment would ________ physical capital accumulation. A.  Reduce ; increase ; increase B. Increase ; increase ; increase C. Increase ; increase ; reduce D. Reduce ; reduction; reduce

Answer 1

i).

Here the savings and the investment functions are given by.

=> “S = 150 + 50*r” and “I = 600 - 100*r”. So, at the equilibrium “S” must be equal to “I”.

=> S = I, => 150 + 50*r = 600 - 100*r, => 150*r = 450, => r = 3%, => the correct option is “C”.

ii).

Now, the investment function is given by, “I = 600 - 100*r = 600 - 100*3 = 300, => the correct option is “A”.

iii).

Now, “Y” is “1000”, => “Y=1,000” and the savings is “I=300”, => the consumption is given by.

=> C = Y - I - G = 1,000 - 300 - 100 = 600. So, here the correct answer is “D”,

iv).

Now, the private savings is given by, => Sp = Y-T-C = 1,000 - 100 - 600 = 300. So, the correct answer is “B”.