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).

Answer 1

a. Increase in household's income: As there is increase in the household income of the consumers, private savings of the households will increase. This will increase National savings and this increases the supply of loanable funds in the market. The rightward shift of the supply curve to S'S' will shift equilibrium from point E1 to point E2 which leads to fall in the rate of interest in the loanable funds market and increases the equilibrium amount of savings and investment in the economy.

b.  A rise in expected future marginal productivity of capital : Rise in the productivity of capital will increase the demand for capital and as the demand for capital increases, the demand for loanable funds will also increase to D'D" which leads to increase in the equilibrium rate of interest and equilibrium amount of savings and investment in the economy.

c. An increase in current output (income). As output in the economy increases, the demand for capital will also increase and this will increase equilibrium rate of interest and equilibrium amount of savings and investment in the loanable funds market.