Question

Suppose that every additional three percentage points in the investment rate (1 + GDP) boost economic growth by one percentage point. Assume also that all investment must be financed with consumer saving. The economy is now assumed to be fully employed at GDP Consumption Saving Investment $16 trillion 10 trillion 3 trillion 3 trillion If the goal is to raise the economic growth rate by 1 percent, Instructions: Enter your responses as a whole number. a. By how much must investment increase? $ billion b. By how much must consumption decline for this to occur?

Answer 1

Initial (I/GDP) ratio = (3/16) = 0.1875 = 18.75%

Initial government spending ($ trillion) = GDP - Consumption - Investment = 16 - 10 - 3 = 3

(a)

For 1% increase in economic growth, (I/GDP) must rise by 3%.

New value of (I/GDP) = 18.75% + 3% = 21.75%

New GDP ($ trillion) = 16 x 1.01 = 16.16

New Investment ($ trillion) = 16.16 x 0.2175 = 3.5148

Increase in investment ($ trillion) = 3.5148 - 3 = 0.5148

Increase in investment ($ billion) = 0.5148 x 1000 = 514.8 ~ 515

(b)

To increase investment by $515 billion, Saving must increase by $515 billion.

New saving ($ trillion) = 3 + 0.515 = 3.515

New Consumption ($ trillion) = New GDP - New I - Government spending = 16.16 - 3.5148 - 3 = 9.6452

Decrease in consumption ($ trillion) = 10 - 9.6452 = 0.3548

Decrease in consumption ($ biillion) = 0.3548 x 1000 = 354.8 ~ 355