Consider an economy described as follows: Y=C+ I+G Y = 8000 G = 2500 T = 2000 C = 1000 + (2/3)*(Y-T) I = 1200 – 100r a. In this economy, compute private saving, public saving, and national saving. b. Find the equilibrium interest rate. c. Now suppose that G is reduced by 500. Compute private saving, public saving, and national saving. d. Find the new equilibrium interest rate.

a. Private Saving = 1000; Public Saving = –500; and National saving = 500.

b. Equilibrium interest rate = r = 7

c. Private Saving = 1000; Public Saving = 0; and National saving = 1000.

d. New equilibrium interest rate = 2

Explanation:

Y=C+ I+G

Y = 8000

G = 2500

T = 2000

C = 1000 + (2/3)*(Y-T) = 1000 + (2/3)*(8000-2000) = 5000

I = 1200 – 100r

8000 = [1000 + (2/3)*(8000-2000)] + [1200 – 100r] + 2500

a. In this economy, compute private saving, public saving, and national saving.

Private Saving = Y - T - C = 8000 - 2000 - 5000 = 1000

Public Saving = T - G = 2000 - 2500 = -500. This implies a budget deficit or a borrowing by the government from the private saving.

National saving = Y - C - G = 8000 - 5000 - 2500 = 500

b. Find the equilibrium interest rate.

National saving = I

Therefore, we have:

500 = 1200 – 100r

500 - 1200 =  – 100r

– 700 = – 100r

r =  –700/–100) = 7

c. Now suppose that G is reduced by 500. Compute private saving, public saving, and national saving.

Private Saving = Y - T - C = 8000 - 2000 - 5000 = 1000

Public Saving = T - G = 2000 - 2000 = 0. This a balanced budget.

National saving = Y - C - G = 8000 - 5000 - 2000 = 1000

d. Find the new equilibrium interest rate.

New national saving = I

Therefore, we have:

1000 = 1200 – 100r

1000 - 1200 =  – 100r

– 200 = – 100r

r =  – 200/–100 = 2

the correct answer is:

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