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Econ1102

In: Business and Management

Submitted By caitianyu
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Tutorial 2 question 5 (i). The following figure1 illustrates the effect of the $20 billion decrease in the government borrowing. Initially, the supply of saving is curve S1, the demand for saving is the curve I, the equilibrium real interest rate is i1, and the equilibrium quantity of funds is Q1. The decrease in the government borrowing by $20 billion increases the supply of saving at each real interest rate by $20 billion, so the supply curve S1 shits to the right and is represented by new supply curve S2. As a result, the real interest rate decreases from i1 to the new equilibrium i2. (ii). Because the real interest rate decreases, investment and national saving increase. From the figure 1, it could be seen that both national saving and investment increase by less than $20 billion (from Q1 to Q2). Since public saving increases by $20 billion, according to the formula: Investment=national saving=public saving + private saving, private saving will decrease by less than $20 billion. (iii). From figure 2, it could be seen that the more elastic the demand for saving, the flatter the demand curve would be, so the real interest rate will decrease by less (from i1 to i’2) and the national saving and investment will increase by more (from Q1 to Q’2). Because public saving still increases by $20 billion, private saving will decrease by less. (iv). If households believe that lower government borrowing today implies lower taxes to pay off the government debt tomorrow, they will save less and consume more. Therefore, private saving will decrease, and the supply of the saving will also decrease. This will offset the increase of the public saving, thus reducing the amount by which the equilibrium quantity of investment and national saving increases, and reducing the amount by which the interest rate decreases. (v). Lifecycle saving aims to meet long-term…...

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