Question

For each of the following scenarios, use the goods market (investment-saving) diagram to identify changes in saving and investment curves. Provide a separate diagram with original and new curves for each scenario. Determine the changes in the interest rate and equilibrium quantities of investment and saving. a. An expected increase in households’ income. b. A rise in expected future marginal productivity of capital. c. An increase in current output (income).

Please make sure it is expected not current!

Answer 1

In following graphs, I0 and S0 are initial investment and saving curves, intersecting at point A with initial interest rate r0 and quantity of saving and investment Q0.

(a)

Expected increase in household income makes households increase current consumption. This decreases current savings, shifting savings curve to left. Interest rate increases and quantity of saving and investment decreases.

In following graph, S0 shifts left to S1, intersecting I0 at point B with higher interest rate r1 and lower quantity of saving and investment Q1.

(b)

Increase in expected marginal productivity of capital increases expected future profitability, so firms increase current investment, shifting investment curve to right. Interest rate increases and quantity of saving and investment increases.

In following graph, I0 shifts right to I1, intersecting S0 at point B with higher interest rate r1 and higher quantity of saving and investment Q1.

(c)

Increase in current income increases both current consumption and savings. This shifts savings curve to right. Interest rate decreases and quantity of saving and investment increases.

In following graph, S0 shifts right to S1, intersecting I0 at point B with lower interest rate r1 and higher quantity of saving and investment Q1.