(35) Consumption and Saving (10) Suppose the real interest rate falls. Describe
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Question
(35) Consumption and Saving (10) Suppose the real interest rate falls. Describe the effect on consumption and on national saving. Is this a movement along the saving curve or a shift in the curve? (10) Suppose a tax cut is announced today, but it will take effect next year a. b. i. If some portion of the population is borrowing constrained, what will be the effect on national saving today? Illustrate. (15) Current GDP (Y) increases. What happens to desired consumption (C)? Explain. c. Illustrate the effect on the national saving curve. Explain?Explanation / Answer
1.If interest rate falls then opportunity cost of holding cash falls.Holding more cash encourages to spend more.Thus,consum consu increases.
People will sarts holding more cash and depositing less into their accounts.
Since,the interest rate falls the returns from savings fall.
Overall savings would fall and consumption would rise.
This is a movement along the savings curve because interest rate is an endogenous variable.
B.National savings today will rise.After a year from now the disposable income is supposed to fall due to a rise in taxes.So,people will have less to save from the next year onwards.
Thus,current savings rate would rise.
C.When GDP rises the income rises which increases desired consumption.But an income increase also induces increase in savings.
The magnitude of increase in consumption/saving would be determined by the MPC and MPS.
Since we dont' have that data,let's just assume that both these effects cancel out each other and there is no change in national savings.
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