Question

An economy has full-employment output of 5000 . Government purchases are 1000 . Desired consumption was initially given by

Cᵈ = 3000 − 2000r + 0.1Y

But a shock to wealth causes desired consumption to decline by 200 , so that the new desired consumption becomes

Cᵈ =2800 − 2000r + 0.1Y

Desired investment is the same as given in this question. e.g.

Iᵈ=1000−4000r

Fill in the blank.
i) A decrease in desired consumption (1) ______ desired savings and the savings curve (2) ____. Thus the equilibrium real interest rate [3] ______.

Answer 1

A decrease in desired consumption leads to an increase in desired savings, causing the savings curve to shift upwards. Consequently, this results in a decrease in the equilibrium real interest rate.

Step-by-step explanation:

The student is asking about how a decrease in desired consumption affects savings and the equilibrium real interest rate in an economy. When we analyze this question, we apply the concepts of savings, consumption, and interest rate to find the relationship between them.

If desired consumption decreases by 200 (from Cᵈ = 3000 - 2000r + 0.1Y to Cᵈ = 2800 - 2000r + 0.1Y), it means that at each level of income, households want to consume less and therefore save more.

This increase in desired savings shifts the savings curve upwards. With greater savings available at each interest rate, the equilibrium real interest rate will decrease, ensuring that savings equal investment at a new lower interest rate.

So, to fill in the blanks: i) A decrease in desired consumption (1) increases desired savings and the savings curve (2) shifts upwards. Thus the equilibrium real interest rate [3] decreases.