During a recession, consumers may want to save more to provide themselves with a

Question

During a recession, consumers may want to save more to provide themselves with a reserve to cushion possible job losses.

a) Use the Keynesian cross model to describe the impact of an exogenous decrease in consumption (i.e. a decrease in current C not due to a change in current disposable income) on the equilibrium level of income in the economy. Illustrate graphically. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v. the terminal equilibrium values.

b) Will aggregate national saving increase? Explain briefly why or why not.

Explanation / Answer

A reduction in exogenous consumption reduces scheduled spending, which reduces the equilibrium level of income by a superior amount via the consumption spending multiplier, i.e., a cut in consumption spending leads to a decrease in income, which leads to another decrease in consumption spending, and so on.

At the new lower equilibrium level of income, both income and consumption spending will have decreased by the same amount, so that national saving ( Y – – G ) will be unchanged

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