Use a saving-investment diagram to explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy.(a)Current output rises due to a temporary productivity increase.(b)The tax code changes so that business firms face higher tax rates on their revenue (offset by other lump-sum tax changes so there's no overall change in tax revenue).(c)The government increases spending temporarily for a one-year project to turn mercury into gold.(d)The average educational level rises, inducing an increase in the future marginal productivity of capital.

What will be an ideal response?


(a)The rise in output raises desired saving, shifting the Sd curve to the right; in equilibrium, this 
reduces the real interest rate, increasing investment as well.
(b)The rise in taxes reduces desired investment, shifting the Id curve to the left; in equilibrium, this 
reduces the real interest rate, reducing saving as well as investment.
(c)The rise in government purchases reduces desired saving, shifting the Sd curve to the left; in 
equilibrium, this raises the real interest rate, reducing investment as well as saving.
(d)The rise in future marginal productivity of capital raises desired investment, shifting the Id 
curve to the right; in equilibrium, this raises the real interest rate, increasing saving as well as investment.

Economics

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