Economics Chapter on Savings and Investment

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Questions and Answers

What is private savings defined as in a closed economy?

Disposable income less consumption (correct)

Tax revenue minus government spending

Disposable income plus consumption

Investment minus taxes

In a closed economy, which equation expresses the relationship between savings and investment?

S = I + (T + G)

I = S + (G - T)

I = S + (T - G) (correct)

S = C + I + G

Under which condition does the government have a fiscal surplus?

When T = G

When T < G

When T = 0

When T > G (correct)

What happens when public savings are negative?

The government has a fiscal deficit Signup and view all the answers

In the formula S = I + (G - T), what does G - T represent?

Public savings Signup and view all the answers

How can private savings be expressed using national income accounting?

S = (Y - T) - C Signup and view all the answers

Which of the following scenarios indicates an imbalance in a closed economy?

Savings are less than investment Signup and view all the answers

What does the equation I = S + (M - X) imply in an open economy?

Investment includes borrowing from abroad Signup and view all the answers

How does an exogenous increase in planned consumption $C̄$ affect planned private savings?

It results in a decrease in planned private savings. Signup and view all the answers

What is the significance of the term $1 - c$ in the planned savings equation $S = (1 - c)(Y - T ) - C̄$?

It indicates the rate of savings out of disposable income. Signup and view all the answers

Why does an increase in private savings potentially lead to a reduction in overall economic output in the Keynesian model?

It reduces consumption demand. Signup and view all the answers

What does the equilibrium output equation $Y = \frac{C̄ - cT̄ + Ī + Ḡ}{1 - c}$ illustrate?

The connection between planned consumption and total output. Signup and view all the answers

What phenomenon explains why increased individual savings might be detrimental to the economy as a whole?

The paradox of thrift. Signup and view all the answers

In the context of the Keynesian model, what role can public dissaving (deficit spending) play during increased private savings?

It can counterbalance a decline in overall demand. Signup and view all the answers

What is meant by 'output is demand-determined' in the Keynesian framework?

Output is dictated by the aggregate consumption and investment demand. Signup and view all the answers

Which of the following statements about the planned consumption function $C = C̄ + c(Y − T)$ is true?

It shows that consumption increases with income after taxes. Signup and view all the answers

If the marginal propensity to consume (c) is 0.5, C̄ is 200, and I¯ is 100, what is the equilibrium output (Y)?

600 Signup and view all the answers

What happens to equilibrium output (Y) if C̄ decreases to 150 while c remains at 0.5?

Y decreases to 500 Signup and view all the answers

In the context of the paradox of thrift, what does increased planned savings lead to in the short run?

A recession as output adjusts Signup and view all the answers

What is the effect of an increase in government spending (Ḡ) on short-run output when c is 0.5?

Increases output more than a decrease in taxes Signup and view all the answers

If planned investment (Ī) is held constant, what must happen when households increase their savings?

Output must decrease until savings equal investment Signup and view all the answers

What is the impact of public dissaving, where T̄ − Ḡ = −50, on the paradox of thrift?

Neutralizes the impact of saving increases Signup and view all the answers

Which of the following equations shows the relationship for determining equilibrium output?

$Y = \frac{C̄ - cT̄ + Ī + Ḡ}{1-c}$ Signup and view all the answers

When comparing the effects of increasing government spending (Ḡ) versus decreasing taxes (T̄), which gives a larger effect on short-run output?

Increasing Ḡ Signup and view all the answers

An increase in autonomous consumption $C̄$ leads to a decrease in planned private savings.

True Signup and view all the answers

In the Keynesian model, increased savings always leads to higher economic output.

False Signup and view all the answers

The equation for planned private savings is $S = (Y - T) - C$.

False Signup and view all the answers

Equilibrium output can be affected by changes in planned investment $I$ and planned savings $S$.

True Signup and view all the answers

According to the paradox of thrift, individual households saving more may negatively impact the economy.

True Signup and view all the answers

The marginal propensity to consume $c$ represents the portion of income that is saved.

False Signup and view all the answers

Public dissaving through deficit spending can help offset the negative effects of increased private savings.

True Signup and view all the answers

The planned savings function shifts down when there is a decrease in autonomous consumption $C̄$.

False Signup and view all the answers

In a closed economy, public savings is defined as $T - G$.

True Signup and view all the answers

When the government has a fiscal surplus, it means that $G > T$.

False Signup and view all the answers

In an open economy, investment can be expressed as $I = S + (T - G) + (M - X)$.

True Signup and view all the answers

The equation $S = I + (G - T)$ can be manipulated to show that $I = S - (G - T)$.

False Signup and view all the answers

If the marginal propensity to consume (c) is 0.5, and C̄ is 150, the equilibrium output Y becomes 500.

True Signup and view all the answers

A paradox of thrift suggests that increased savings can lead to a decrease in overall economic output.

True Signup and view all the answers

An increase in planned savings always leads to an increase in equilibrium output Y.

False Signup and view all the answers

In the equation for private savings, $S = (Y - T) - C$, $C$ stands for total consumption including investments.

False Signup and view all the answers

If public savings are negative, the government must be operating with a fiscal surplus.

False Signup and view all the answers

A decrease in consumption ($C̄$) can result in a recession if households increase their planned savings.

True Signup and view all the answers

In a closed economy, if private savings increase and investment remains constant, economic output must increase.

False Signup and view all the answers

The formula for equilibrium output shows that public savings must always be greater than private savings.

False Signup and view all the answers

Public dissaving occurs when T̄ is less than Ḡ, resulting in a budget deficit.

True Signup and view all the answers

Fiscal stimulus through government spending can counteract the reduction in consumer spending caused by an increase in planned savings.

True Signup and view all the answers

A decrease in taxes ($T̄$) has a larger impact on short-run output compared to an increase in government spending ($Ḡ$).

False Signup and view all the answers

If the planned investment ($Ī$) remains constant, then an increase in private savings must lead to a decrease in planned consumption.

True Signup and view all the answers

How does an exogenous decrease in autonomous consumption $C̄$ affect the planned private savings function?

It causes the planned private savings function to shift upwards, indicating that there is more saving at any level of income $Y$. Signup and view all the answers

What is the relationship between planned savings and planned investment in achieving equilibrium output?

Equilibrium output occurs when planned savings equals planned investment, expressed as $I = S + (T - G)$. Signup and view all the answers

In the context of the paradox of thrift, what is the consequence of households saving more?

Households saving more can lead to reduced overall consumption demand, which results in lower equilibrium output. Signup and view all the answers

How is equilibrium output $Y$ determined in a simple Keynesian economy when autonomous consumption $C̄$ changes?

Equilibrium output $Y$ is determined by the formula $Y = \frac{C̄ - cT̄ + Ī + Ḡ}{1 - c}$, adjusting for any change in $C̄$. Signup and view all the answers

Why can public dissaving be beneficial during a period of increased private savings?

Public dissaving, through deficit spending, can offset the drop in consumption demand resulting from higher private savings. Signup and view all the answers

What does the term 'demand-determined' output imply in the Keynesian framework?

It implies that output levels are primarily influenced by consumer demand rather than supply-side factors. Signup and view all the answers

In the equation for planned private savings $S = (Y - T) - C$, what components does $C$ represent?

In this equation, $C$ represents total consumption, which is influenced by disposable income and other factors. Signup and view all the answers

What happens to planned saving if autonomous consumption $C̄$ increases?

An increase in $C̄$ leads to a decrease in planned private savings since $S$ is negatively related to changes in $C̄$. Signup and view all the answers

How does the assumption of a closed economy impact the relationship between savings and investment?

In a closed economy, investment is determined by the sum of private savings and public savings, expressed as $I = S + (T - G)$. This means there is no foreign savings or investments altering the total savings and investment balance. Signup and view all the answers

What is the paradox of thrift, and how can it affect overall economic output?

The paradox of thrift states that when individuals increase their savings during economic downturns, overall demand can decrease, leading to a reduction in economic output. Consequently, the higher savings may not correlate with higher national savings due to decreasing consumption. Signup and view all the answers

In what scenario would a government be considered to have a fiscal deficit?

A government has a fiscal deficit when public savings are negative, which occurs when tax revenue $T$ is less than government spending $G$ (i.e., $T < G$). Signup and view all the answers

Why is public saving represented by the equation $T - G$, and what does it signify?

Public saving is calculated as $T - G$, representing the difference between tax revenue and government spending. A positive value indicates surplus, while a negative value signifies a deficit. Signup and view all the answers

How does an increase in planned savings influence overall consumption in the Keynesian model?

An increase in planned savings can lead to a decrease in overall consumption, as households choose to save rather than spend more of their disposable income. This can negatively impact aggregate demand and economic output. Signup and view all the answers

What does the equation $I = S + (T - G)$ tell us about the components of investment in a closed economy?

The equation $I = S + (T - G)$ shows that in a closed economy, total investment $I$ is financed by domestic private savings $S$ plus net public savings ($T - G$). Signup and view all the answers

Describe the implications of a balanced government budget ($G = T$) on national investment.

When the government budget is balanced with $G = T$, the equation simplifies to $I = S$, indicating that domestic investment is wholly supported by private savings without public surplus or deficit. Signup and view all the answers

How do changes in government spending ($G$) affect equilibrium output in a closed economy?

Changes in government spending ($G$) directly influence equilibrium output as higher government spending can elevate total demand, leading to increased output, given a stable level of consumption and investment. Signup and view all the answers

Explain how a decrease in planned consumption ($C̄$) impacts equilibrium output ($Y$) in the Keynesian model.

A decrease in planned consumption ($C̄$) leads to a lower equilibrium output ($Y$) because the equation for $Y$ shows that it is inversely related to $C̄$. This adjustment occurs as households attempt to save more, resulting in reduced overall demand. Signup and view all the answers

In the context of the Keynesian model, what role does fiscal stimulus play when private savings increase?

Fiscal stimulus, through increased government spending, offsets the decline in consumer spending due to higher private savings. It helps maintain equilibrium output by stimulating demand even when households save more. Signup and view all the answers

How do changes in the marginal propensity to consume (c) affect the equilibrium output ($Y$) according to the formulas provided?

Changes in the marginal propensity to consume (c) affect equilibrium output ($Y$) by altering the denominator in the output equation, thereby changing the responsiveness of output to shifts in consumption or savings. For example, a lower $c$ increases the multiplier effect on output. Signup and view all the answers

Discuss the implications of public dissaving when the government has negative public savings ($T̄ - Ḡ < 0$).

Public dissaving indicates that the government is running a deficit, which can provide additional demand in the economy, counteracting the downturn caused by rising private savings. It plays a crucial role in maintaining total output and economic activity. Signup and view all the answers

What does the equation $Y = rac{C̄ - cT̄ + Ī + Ḡ}{1 - c}$ suggest about the relationship between fiscal policy and output?

The equation indicates that output ($Y$) is influenced by both consumption ($C̄$) and government intervention ($Ḡ$), suggesting that fiscal policies can directly impact economic output. It highlights that increases in government spending or decreases in taxation can stimulate output. Signup and view all the answers

Explain why an increase in planned savings does not necessarily lead to an increase in actual private savings.

An increase in planned savings may not change actual private savings because households may not have the ability or willingness to save more in the short run, given constant planned investment. Instead, output adjusts to maintain the equality of savings and investment. Signup and view all the answers

In comparing the effects of an increase in government spending versus a decrease in taxes, which is deemed more effective for stimulating short-run output?

An increase in government spending ($Ḡ$) is generally deemed more effective than a decrease in taxes ($T̄$) for stimulating short-run output, as it directly injects demand into the economy without reliance on consumer response. Signup and view all the answers

What happens to equilibrium output ($Y$) if both consumption ($C̄$) and government spending ($Ḡ$) increase simultaneously?

If both consumption ($C̄$) and government spending ($Ḡ$) increase, the equilibrium output ($Y$) will rise since both components contribute positively to total demand in the economy. This results in greater overall economic activity. Signup and view all the answers

In a closed economy, private savings can be expressed as S = I + (G - ______)

T Signup and view all the answers

The ______ of thrift refers to the situation where increased individual savings lead to a decrease in overall economic output.

paradox Signup and view all the answers

In an open economy, investment can be calculated using the equation I = S + (T - G) + (M - ______)

X Signup and view all the answers

When ______ savings is positive, it indicates that the government has a fiscal surplus.

public Signup and view all the answers

The equation S = (Y - T) - C describes how to calculate planned private ______.

savings Signup and view all the answers

In Keynesian economics, increased savings can negatively impact the economy due to the ______ of thrift.

paradox Signup and view all the answers

If the government has a fiscal ______, it means that tax revenue is less than government spending.

deficit Signup and view all the answers

The relationship I = S + (T - G) can show that in a closed economy, total investment is equal to ______ savings plus public savings.

private Signup and view all the answers

In the planned savings equation, S = (1 − c)Y − ______, C̄ represents autonomous consumption.

C Signup and view all the answers

Equilibrium output is determined by the equation Y = ______ (C̄ + I) / (1 − c).

I Signup and view all the answers

When C̄ decreases, the short-run equilibrium output Y can ______ as a direct consequence.

fall Signup and view all the answers

Public dissaving represented by T̄ − Ḡ = ______ can help offset the paradox of thrift.

-50 Signup and view all the answers

An increase in Ḡ has a ______ impact on short-run output compared to a decrease in T̄.

bigger Signup and view all the answers

If actual private savings does not change despite an increase in planned savings, it indicates that output ______ must adjust.

Y Signup and view all the answers

According to the paradox of thrift, if all households try to increase savings, it can lead to a ______.

recession Signup and view all the answers

In the Keynesian model, the short-run output formula shows the relationship as Y = ______ (C̄ − cT̄ + I + Ḡ).

1/(1 − c) Signup and view all the answers

Planned private savings is expressed as S = (1 − c)(Y − T ) − ______

C̄ Signup and view all the answers

According to the paradox of thrift, increased savings can lead to a decrease in overall economic ______.

output Signup and view all the answers

In the Keynesian model, if output is demand-determined, then increased savings may ultimately result in ______ consumption demand.

less Signup and view all the answers

For equilibrium output, the equation is defined as Y = ______ / (1 − c).

C̄ − cT̄ + Ī + Ḡ Signup and view all the answers

An exogenous increase in planned consumption C̄ leads to a decrease in planned private ______.

savings Signup and view all the answers

In a simple Keynesian economy without government spending, both Ḡ and T̄ are equal to ______.

0 Signup and view all the answers

Public dissaving can offset an increase in private savings, particularly when households become ______.

thrifty Signup and view all the answers

The marginal propensity to save is represented as ______.

1 − c Signup and view all the answers

Study Notes

Savings and Investment

Private savings is defined as disposable income less consumption: S = (Y − T) − C
In a closed economy, investment equals private savings plus public savings: I = S + (T − G)
A positive public savings leads to a fiscal surplus (T > G), and a negative one leads to a fiscal deficit (T < G)

Keynesian Model Revisited

Planned private savings can be expressed as S = (1 − c)(Y − T) − C̄, where (1 − c) is the marginal propensity to save
An increase in planned consumption C̄ is equivalent to a decrease in planned private savings

Savings and Investment in Equilibrium

Equilibrium output is when planned investment and planned savings are equal
In equilibrium, I = S + (T − G)
Given constant T and G, equilibrium output can be calculated using the equation I = (1 − c)(Y − T̄) − C̄ + T̄ − Ḡ
Equilibrium output is given by: Y = (C̄ − cT̄ + I¯ + Ḡ) / (1−c)

Paradox of Thrift

Increasing private savings by decreasing autonomous consumption C̄ leads to a higher savings function
However, this also leads to a lower equilibrium output
The paradox of thrift highlights how increased individual savings can negatively impact the overall economy
Public dissaving (deficit spending) can potentially offset increased private savings

Savings and Investment

Savings is defined as disposable income minus consumption.
In a closed economy, investment equals private savings plus public savings.
Public savings is the difference between tax revenue and government spending.
When public savings are positive, the government has a fiscal surplus.
When public savings are negative, the government has a fiscal deficit.

Keynesian Model Revisited

Planned private savings are equal to (1 - c)(Y - T) - C̄, where 1 - c is the marginal propensity to save.
An exogenous increase in planned consumption is equivalent to an exogenous decrease in planned private savings.

Paradox of Thrift

An increase in private savings can lead to a decrease in equilibrium output.
Households becoming more thrifty can be harmful to the economy overall.
Public dissaving can offset the effects of an increase in private savings.

Simple Keynesian Economy Example

Assuming no government spending or taxation, equilibrium output is determined by planned investment and planned private savings.
An increase in planned private savings reduces equilibrium output because it decreases consumption demand.
Despite the increase in private savings, actual private savings remain unchanged.

Fiscal Stimulus

Fiscal stimulus can offset a decrease in consumer spending by increasing government spending or decreasing taxes.
Increasing government spending has a bigger impact on short-run output than decreasing taxes.

Savings and Investment in a Closed Economy

In a closed economy, private savings (S) are defined as disposable income (Y-T) minus consumption (C): S = (Y - T) - C
Private savings can also be expressed as S = I + (G - T), where I is investment, G is government spending, and T is taxes.
Investment in a closed economy equals private savings plus public savings: I = S + (T - G)
Public Savings: If T > G, the government has a fiscal surplus. If T < G, the government has a fiscal deficit.

The Paradox of Thrift

Increased savings can negatively impact the economy in the short run because it reduces consumption demand.
Short-run output is demand-determined, so increased savings can lead to lower output.
Individual households being thrifty could paradoxically be detrimental to the overall economy.
Public dissaving (deficit spending) can offset the negative impact of increased private savings.

Keynesian Model and Equilibrium

Planned private savings are given by S = (1 - c)(Y - T) - C̄, where c is the marginal propensity to consume and C̄ represents autonomous consumption.
Equilibrium output occurs when planned investment and planned savings are equal.
Equilibrium output can be calculated as: Y = (C̄ - cT̄ + I¯ + Ḡ) / (1 - c)

Example: A Simple Keynesian Economy

The example assumes no government spending or taxes (Ḡ = T̄ = 0).
Planned private savings are S = (1 - c)Y - C̄.
Equilibrium output is Y = (C̄ + I¯) / (1 - c), where I¯ represents planned investment.
If c = 0.5, C̄ = 200, and I¯ = 100, equilibrium output is Y = 600, and private savings are S = I¯ = 100

Example: Increase in Planned Savings

An increase in planned private savings (decreased C̄) leads to lower equilibrium output.
While planned savings increase, actual private savings remain equal to I¯.
Households attempting to increase their savings collectively can induce a recession because this reduces demand.

Fiscal Stimulus

Fiscal stimulus can offset the paradox of thrift by increasing government spending (Ḡ) or decreasing taxes (T̄).
Increased Ḡ has a larger impact on short-run output compared to a decrease in T̄.
Fiscal stimulus can recover equilibrium output, even in the face of increased private saving.

Savings and Investment

In a closed economy, private savings are disposable income minus consumption, expressed as: S = (Y − T ) − C
This can be rearranged using the national income accounting identity (Y = C + I + G), to express private savings as: S = I + (G − T )
Public savings are defined as excess tax revenue over government spending, expressed as: (T - G)

Key Point: Investment in a Closed Economy

Domestic investment in a closed economy is equal to private savings plus public savings: I = S + (T − G)
Public savings can be positive, resulting in a government fiscal surplus (T > G).
Public savings can be negative, resulting in a government fiscal deficit (T < G).

Keynesian Model Revisited

Planned private savings are equivalent to: S = (1 − c)(Y − T ) − C̄
An increase in planned consumption C̄ is equivalent to an exogenous decrease in planned private savings.

Savings and Investment in Equilibrium

Equilibrium output is found when planned investment and savings are equal: I = S + (T − G)
The equilibrium level of output can be expressed as: Y = (C̄ − cT̄ + I¯ + Ḡ)/(1−c)

Paradox of Thrift

More saving (being thrifty) does not always improve the economy, and in some cases, it can actually reduce output.
An increase in planned private savings shifts the savings function upwards, resulting in more savings at any level of output.
This leads to a lower equilibrium level of output.

Explanation of Paradox of Thrift

In the Keynesian model, short-run output is demand-determined.
Increased savings lead to less consumption, causing a decrease in output.
Therefore, individual households being thrifty might be bad for the overall economy.

The Importance of Savings

In the short-run, increased savings can reduce output.
In the long-run, savings can lead to supply-side benefits, increasing the economy’s productive capacity.

Example: Simple Keynesian Economy

In the absence of government spending or taxation (Ḡ = T̄ = 0), the equilibrium output is found by solving: I¯ = (1 − c)Y − C̄
Example with specific values: c = 0.5, C̄ = 200, and I¯ = 100, yields equilibrium output of 600.

Example: Increase in Planned Savings

A decrease in C̄ to 150 lowers equilibrium output to 500.
This demonstrates that more savings don't necessarily lead to more investment, but rather output adjusts to match savings and investment.

Example: Fiscal Stimulus

Offset the decrease in consumer spending with an increase in government spending.
Setting Ḡ = 50 with T̄ = 0, the equilibrium output recovers to 600.
This illustrates how government spending can counteract the paradox of thrift.

Fiscal Stimulus: Increase Ḡ or Decrease T̄?

An increase in government spending (Ḡ) has a larger effect on short-run output compared to reducing taxes (T̄) for a given increase in the budget deficit.
This is due to the multiplier effect, which is greater when government expenditure increases.

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Description

This quiz covers the fundamental concepts of savings and investment in economics, focusing on private and public savings, equilibrium output, and the paradox of thrift. It revisits the Keynesian model and explores the implications of fiscal surpluses and deficits. Test your understanding of these crucial economic principles!