Question

Saving and investment in a closed economy

Assume that the private consumption function takes the following form: C=a+b *(Y−T), where a and b are some positive numbers. Assume that b=0.4 and that government increases personal income taxes by $1 billion.
a) Compute the effect on private consumption
b) Compute the effect on private saving
c) Compute the effect on public saving
d) Compute the effect on national saving
e) Compute the effect on national saving if b=1

Answer 1

The effect on private consumption, private saving, public saving, and national saving can be calculated using formulas based on the given information.

Step-by-step explanation:

a) The effect on private consumption can be computed by substituting the new value of taxes into the consumption function. Given that b = 0.4, we have:
C = a + b * (Y - T)
C = a + 0.4 * (Y - (T + 1 billion))

b) The effect on private saving can be obtained by subtracting the increase in consumption from disposable income. The formula for private saving is:
S = Y - C

c) The effect on public saving can be computed by subtracting the increase in taxes from government spending. The formula for public saving is:
S_public = G - T

d) The effect on national saving can be calculated by summing up private and public saving. The formula for national saving is:
S_national = S_private + S_public

e) If b = 1, the effect on national saving can be calculated using the formulas in parts c and d.