Ch. 3 - ECN101 Intermediate Macroeconomics Professor...

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ECN101 Intermediate Macroeconomics Fall 2008 Professor E.A.Frenkel Homework 3 solutions (3)Problem: Let's say you are a macroeconomic policy maker and you want to increase national savings. You have control over government spending and taxing decisions. What would you suggest as a policy to raise total savings. SOLUTION: You can reduce government expenditure (G), so that government saving (T-G) and hence total saving would increase. Or you can increase tax (T), so that consumption decreases and total saving Y-C-G increases. (4)Now, using the saving and investment graph from the end of the chapter (the one we used in lecture, with "S" NOT dependent on the real interest rate) trace through and explain what would happen to the real interest rate and to the level of investment if you pursued your policy in (3) above. If your government does not want to see a change in the real rate of interest once national savings are increased, what do you suggest doing in this case? (Using the logic of the graph, of course). SOLUTION: An increase in saving shifts the saving schedule to the right. This increases the amount of investment and reduces the real interest rate. To keep real interest rate stay at its original level r 1 * , the government could (a) encourage investment demand so that the investment schedule also shifts to the right, with the new equilibrium results in an unchanged real interest rate and increased investment amount. The government can encourage investment through tax laws. (b) Increase its spending to
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This note was uploaded on 01/16/2011 for the course ECN 101 taught by Professor Frenkel during the Winter '10 term at UC Davis.

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Ch. 3 - ECN101 Intermediate Macroeconomics Professor...

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