Question

Suppose that the closed economy of an island H is described by the following equations: GDP (Y) = 10000, government expenditures (G) = 600, Taxes (T) = 2000, Consumption (C) = 400 + 3/4 (Y-T), and investment (I) = 200 – 1400 r

a. Write and explain the equation of the GDP

b. Compute

1. Private saving

2. Public saving

3. National saving

4. Equilibrium interest rate

c. What can you conclude about the economy of Island H?

Answer 1

Answer

1. Private savings = 3600
2. Public savings = 1400
3. National savings = 5000
4. Equilibrium interest rate is negative (-) 200 percent
5. Since interest rate is negative on island H, firms are getting benefits by taking loans from Bank

Given,

GDP (Y) = 10000

Government expenditure (G) = 600

Taxes (T) = 2000

Consumption (C) = 400 + (0.75*(Y-2000))

Investment (I) = 200 -1400r

When Y is 10000

Consumption will be

C = 400 + (0.75(10000-2000))

C = 400 +0.75*8000

C = 400 + 6000

C = 6400

GDP/Income = Y =10000

Consumption = C = 6400

Private savings = Y-C = 10000 -6400 =3600

Public income = Taxes (T) =2000

Public expenditure (G) = 600

Public savings = Public Income (T) – Public Expenditure (G) = 2000 -600 =1400

National Savings = Private Savings + Public Savings = 3600 +1400 = 5000

Now,

At equilibrium

GDP (Y) = Consumption(C) + Government Expenditure (G) +Investment (I)

10000 = 6400 +600 +200 -1400r

2800 = -1400r

2800/1400 = -2= r

R = -2 or -200 percent