Question

If consumers are more optimistic about their future (they expect taxes to be reduced, economy will continue to prosper), will most people save more or less than before? Does national saving rise or fall? What will happen to real interest rate. Please give detailed explanation.

Answer 1

When consumers are more optimistic about their future, expecting taxes to be reduced and income to increase from prosperous economy, they increase consumption expenditure, MPC remaining unchanged. Assuming MPC is higher than MPS, higher consumption demand will decreasing savings. People will save less than before, decreasing private saving.

National saving being the sum of public saving and private saving, lower private saving will decrease national saving, public saving remaining unchanged.

As national saving decreases, the saving schedule shifts leftward, which increases real interest rate. Also, higher income in the economy will increase investment demand, shifting investment schedule rightward, increasing real interest rate.