Question

In the old days, if you wanted to retire, you had to save money while you were working (or have kids, but let's just ignore that element). Let's imagine that the government decides to implement a plan whereby they take money from people who are working and give it to people who are old/retired. What effect is this likely to have in the market for loanable funds? Show on a graph. What effect would you expect this to have on the steady-state levels of capital and output. Show on another graph.

Answer 1

Market for loanable funds:

When some part of the individual's income is taken by the government in the form of taxes, then as a result this will lead to a fall in the disposabal income of the individual. Hence, this decrease in the disposabal income will lead to decrease the savngs and therefore, less money is available for lending. So, there is a fall in the supply of loanable funds in the market. In the above diagram, this decrease in the supply of loanable funds will lead to shift the supply curve of loanable funds leftwards from SS to SS'. An equilibrium shifts from E to E', the interest rate increases from i to i' and the quantity of loanable funds decreases from Q to Q'.

The consistent state level of capital is a measure of capital for every laborer that is steady after some time - as time advances there is no aggregation or depletion of capital. It happens when the investment in the per capita capital stock is equivalent to the devaluation of the capital stock. This is appeared above graphically, where k* is the consistent state level of capital and the relating output level is the consistent state level of output.

However, when salary is taken from the earning individuals and given to retired individuals, this will decreases the capital accumulation simultaneously depreciation or deterioration increases. Both of these circumstances are horrible for an economy. As redirection between the two veers off the economy from the steady state level.