25) Use a saving—investment diagram to explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy. (a)In an agricultural economy, great weather this year promises a bumper crop next year, leading citizens to expect higher income next year. (b)Government regulations going into effect next year will reduce the marginal product of capital. (c)The government increases lump-sum taxes on citizens.
25) Use a saving—investment diagram to explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy.
(a)In an agricultural economy, great weather this year promises a bumper crop next year, leading citizens to expect higher income next year.
(b)Government regulations going into effect next year will reduce the marginal product of capital.
(c)The government increases lump-sum taxes on citizens.
26) An economy has full-employment output of 5000. Government purchases are 1000. Desired consumption and desired investment are given by
Cd = 3000 - 2000r + 0.10Y
Id = 1000 - 4000r
where Y is output and r is the expected real interest rate.
(a)Find the real interest rate that clears the goods market. Assume that output equals full-employment output.
(b)Calculate the amount of saving, investment, and consumption in equilibrium.
(c)If a shock to wealth causes desired consumption to decline by 200 (so that the new equation for desired consumption is Cd = 2800 - 2000r + 0.10Y), find the equilibrium real interest rate, saving, investment, and consumption.
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