Causal Investment
We have seen that one way of characterizing goods market equilibrium is
that Investment = Savings. However, this equilibrium condition does not
tell us whether more savings causes more investment, or whether more
investment causes more savings. While most people have a good intution
as to how having a greater amount of savings can lead to a larger amount
of investment, it is often dicult for people to understand how having
more investment could lead to a larger amount of savings. We will explore
that in this problem.
For this problem, assume there is no government (i.e. G = T = 0), and
the economy is characterized by the following equations:
C = 15000 + 1
2
Y
I = 15000 + 1
4
Y
(a) Using the I = S equilibrium condition, nd equilibrium Y, C, I and
S.
(b) Create a graph of the I = S equilibrium, with I, S on the vertical
axis, and Y on the horizontal axis. Make sure to label all intercepts,
slopes, and equilibrium quantities.
(c) Suppose b0 increases from 15, 000 to 16, 000.
i. What are the new equilibrium values of Y, C, I and S?
ii. Draw this on your graph, and make sure to label the new intercept, and equilibrium quantities.
iii. What is the intuition as to why savings has increased when investment increased? How is this possible?

DETAILED ASSIGNMENT

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