(a) Explain the paradox of saving. Now suppose the economy is characterised by the following behavioural equations:
C = c0 + c1YD
YD = Y – T
I = b0 + b1Y
Government spending and taxes are constant, and investment increases with output.
(b) Suppose that consumers decide to consume less (and therefore to save more) for any given amount of disposable income. Specifically, assume that consumer confidence (c0) falls. What will happen to output?
(c) As a result of the effect on output you determined in part (b), what will happen to investment? What will happen to public saving? What will happen to private saving? Explain. (Hint: Consider the saving-equals-investment characterisation of equilibrium). What is the effect on consumption?
(d) Comment on the following logic: ‘When output is too low, what is needed is an increase in demand for goods and services. Investment is one component of demand, and saving equals investment. Therefore, if the government could just convince households to attempt to save more, then investment, demand for goods and services, and output, would increase.’
The question belongs to Economics and it discusses about explaining the paradox of saving with given equations.
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