Econ HW 8- w/answers

Econ HW 8 w/answers

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Unformatted text preview: Demand Curve) S0=I0 S1=I1 Saving, Investment Higher investment raises the capital stock and increases potential output, at least in the long run. The future economy is b etter off because it can produce more goods and services It is important to recognize that this discussion assumes that the economy always remains at potential output (the self -correction mechanism has done its work). Therefore, this discussion is not concerned with "Keynesian" aggregate demand effects. The results of hig her saving are favorable in theory, as long as output remaining at the potential level. But in practice, if sticky wages or debt deflation effects prevent the self -correction mechanism from working well, the reduction of aggregate demand caused by higher saving may well lead to lower output and employment, possibly even lower investment, at least in the short run. 4. An increase in the budget deficit shifts the demand for funds in the capital market out to the right by the amount of the budget deficit. This shift occurs because the budget deficit is a net increase in the demand for borrowing in the economy. As the diagram below shows, this shift resu lts in a higher equilibrium interest rate (the interest rate moves from r0 to r1). The increase of the interest rate raises firms' cost of capital and discourages their investment. The reduction of investment from I0 to I1 is called investment "crowding out." r Savings r1 r0 I + Govt. Deficit I (Investment) I1 S0=I0 S1 “Crowding Out of I”...
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This document was uploaded on 02/26/2014 for the course ECON 100 at DePauw.

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