Question

1 . ( a ) Define the concept of the paradox of saving ( or the paradox of thrift )

( b ) Suppose the government wants to increase the level of economic activity . Which policy is

likely to be more effective , fiscal policy or monetary policy ?

2 . ( a ) What is a liquidity trap ?

( b ) If the economy was stuck in a liquidity trap , would you advise the use of monetary p

or fiscal policy ?

3 . ( a ) What is crowding out , and when would you expect it to occur

( b ) In the face of substantial crowding out , which will be more successful-fiscal policy or

Answer 1

1. Paradox of thrift/saving. When an economy tries to save a larger proportion of income then total gross saving remains same or decreases. It is because gross Saving=saving rate*Income

when saving rate increases then income decreases leading downward pressure on gross saving. Thus an increase in saving rate doesnot increases gross saving.

b. Govt. should use expansionary fiscal policy in order to increase the level of economic activity because it leads to more production of goods and services and more transaction takes place