For each of the following scenarios, use a well-labeled diagram of the supply an

Question

For each of the following scenarios, use a well-labeled diagram of the supply and demand for saving and investment to analyze the effects on the real interest rate, equilibrium national savings, and equilibrium investment.

a) U.S. military involvement abroad declines. As a result, the government deficit shrinks.

b) A new generation of computer-controlled machines becomes available. These machines produce manufactured goods much more quickly with fewer defects.

c) Concerns about job security cause people to engage in more precautionary savings.

d) Businesses become pessimistic about consumer demand for their products in the future. As a result, they expect that the prices at which they will be able to sell their products at will decline.

Explanation / Answer

As the government reduces its expenditure on military involvements abroad, the national savings would rise. As the savings rise, more funds are available for investment, thus the public investment rises too. A larger investment leads to a fall in the real interest rate. As new machines are available, thus the firms will invest more on this technology and hence lead to lower interest rates due to larger investments. As people are more concerned about job security, they start to save more. Thus, the national savings will rise, and hence more funds will be available for investment. As the businesses become more pessimistic, they expect that the demand in the economy will rise, thus, they can sell their products at a cheaper price and still make enough revenue out of it. This would imply that the consumers will consume more and save less, leading to a decline in savings and less amount of funds available for investment

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