Question

1. Assume a simple model of the US economy with no international trade. Suppose the government, in an effort to stimulate the economy, increases its spending on goods and services without changing taxes.
   1. Using the model of the market for loanable funds, show how this policy will affect the levels of saving, investment, consumption, and total output in the long run. Explain your answers carefully
   2. Suppose the government did not change its level of spending but decreased taxes instead. Show how this policy would affect the levels of saving, investment, consumption, and total output in the long run. Explain your answers.
   3. Now suppose that the government raises spending and raises taxes by exactly the same dollar amount. Show how this policy would affect the levels of saving, investment, consumption, and total output in the long run. Explain your answers.

Answer 1

Answer a)

In the simple structure of economy without the foreign influence , Loanable funds of the country is the sum of saving from people and other entities in economy and ready to lend out to borrowers. The quantity of loanable fund can be described by the supply, demand, as well as prevailing interest rate in the market.

National savings​=Private savings + Public savings + Net Capital Infusion

National saving =[Income – tax- consumption]+ [Tax received –Govt expenses]+NCI

Incidence: Increases its spending on goods and services without changing taxes, i.e NCI

Effect :levels of saving : Total national saving increase but no change in private saving  by this effort

investment: level will reduce

consumption: will increase due to low cost fund available

total output: will increase

Answer b)

Incidence: did not change its level of spending but decreased taxes instead

Effect :levels of saving : Total national saving remain unchanged but private saving will increase by this effort

investment: remain constant at national level

consumption: will increase due to low cost fund available

total output: will increase

Answer c)

Incidence: the government raises spending and raises taxes by exactly the same dollar amount

Effect :

levels of saving : Total national saving remain unchanged but public saving will increase by this effort

investment: remain constant at national level

consumption: will increase due to low cost fund available

total output: will increase