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ECON 200 Problem Set 2 Solutions Fall 2007

ECON 200 Problem Set 2 Solutions Fall 2007 - Economics 200...

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Economics 200 Macroeconomic Theory Solutions to Problem Set 2 1. The relevant model is the loanable funds market. Private saving is given by W œ ]  G  X œ ]  -Ð]  >] ß <Ñ  >] œ Ð"  >Ñ]  -ÐÐ"  >Ñ] ß <Ñ T . Public saving is given by W œ X  K œ >]  K ] K . As is determined by the available quantities of the factors of production and the level of technology, and is exogenous, we can write . Thus a rise in the tax K W œ >]  K K rate unambiguously increases public saving. Private saving is now W œ Ð"  >Ñ]  -ÐÐ"  >Ñ] ß <Ñ T so, for a given , the rise in reduces . To see this, note that disposable income falls and < > W T consumption falls as a result when rises but the fall in the latter is less than that in the former because > the marginal propensity to consume is less than one. We cannot, however, determine what happens to the quantity of until we determine what happens to the real interest rate. National saving, the sum W T of private and public saving, is given by so a rise in the tax rate WÐ<Ñ œ ]  -ÐÐ"  >Ñ] ß <Ñ  K
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