Question

Suppose that a financial crisis hits Econland and reduces the wealth of its households. Assume standard shapes for the production, labor demand, labor supply, saving and investment curves. Further, assume that Econland is a closed economy.

Illustrate the effect of the change in S=S(Y₁,Y₂,W) due to the reduction in wealth on the saving-investment diagram for the market of funds.

Answer 1

A financial crisis in Econland leads to a reduction in household wealth, resulting in a leftward shift in the saving curve of the saving-investment diagram for the market of funds.

Step-by-step explanation:

In this scenario, a financial crisis reduces the wealth of households in Econland, a closed economy. The reduction in wealth affects the Saving (S) curve in the saving-investment diagram for the market of funds. As households experience a decrease in wealth, they tend to save less and consume more. This leads to a leftward shift in the S curve, indicating a decrease in saving.

Consequently, the equilibrium point on the saving-investment diagram will change. The new equilibrium will occur at a lower level of saving and investment compared to the original equilibrium. The interest rate may also be affected, depending on the specific shifts in the demand and supply for funds curves.