Question

1. For each situation, indicate the effects on consumption and saving in the economy:
   1. The federal government increases payroll taxes.
   2. The Federal Reserve reduces key interest rate targets.
   3. Consumers are fearful of a possible recession.
   4. There is an increase in rent and mortgage payments for housing.

NO HAND-WRITE PLEASE

Answer 1

A. When payroll taxes are increased which means people employed will receive less disposable income.This will definitely lead to lower consumption level and lower saving potential of households compared to pre tax stage.But here substitution effect can also come in play which means people will prefer leisure over working hours because they know they will receive less wages.Similarly Income effect can also come into play which means due to lowering of wages some people want to work more hours to gain the additional income which they lost previously.Both the effect depends on tax rate cut.

B. When Fed reduces key interest rate targets then for people it creates an incentive to consume more today and even invest because by saving they will get lower returns today.Therefore consumption increases and saving decreases. People may also take loans for consumption because of lower rates.

C. If consumers are fearful of possible recession in future then there will be a fear of fall of average income and also many people may get unemployed.Therefore it becomes naturally for them to save more today and reduce consumption for a better future. Here Keynes's paradox of thrift comes into play which says that people in fear of recession starts saving more and consume less today which leads to fall in aggregate demand and therefore will definitely cause recession in future.

D. With a limited disposable income and with increased brents and mortgage payment will lead to a decrease in disposable income consumer has. Due to which their will be a simultaneous decrease in both savings and consumption which a consumer does.