Question

Suppose that every additional four percentage points in the investment rate (I ÷ 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

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?

 

     $  billion

Answer 1

a.

Increase in investment to raise the growth rate by 1 percent:

Increase in investment to raise the growth rate by 1 percent is calculated by using data from Table (1).

GDP	$8 trillion
Consumption	$6 trillion
Saving	$1 trillion
Investment	$1 trillion

It is assumed that all the investment is financed with saving and every additional 5 percent increase in investment rate will boost economic growth by 1 percent.

Increase in investment to raise the growth rate by 1 percent is calculated as follows:

\(\begin{aligned} \left.\begin{array}{l}\text { Growth in } \\ \text { investment rate }\end{array}\right] &=\left(\frac{\text { Investment }}{\text { GDP }}\right) \times 100 \\ 5 &=\frac{\text { Investment }}{8} \times 100 \\ \frac{5}{100} &=\frac{\text { Investment }}{8} \\ \text { Investment } &=8 \times 0.05 \\ \text { Investment } &=0.4 \end{aligned}\)

Hence, increase in investment to raise the growth rate by 1 percent is $0.4 trillion.

b.

Fall in consumption to raise investment by $0.08 trillion:

Investment should increase by $0.4 trillion to raise growth rate by 1 percent. Since all investments are assumed to be financed trough consumer saving, saving must increase by $0.4 trillion. Hence, to increase saving by $0.4 trillion, consumption must decline by $0.4 trillion.