Principles of economics (macro)

Saving, Investment, and financial system

Exercises # 4

Question 1: Explain the difference between saving and investment as defined by a

macroeconomist. Which of the following situations represent investment and which represent
saving? Explain.
a) Your family takes out a mortgage and buys a new house.
Investment
b) You use your $200 paycheck to buy stock in AT&T.
Saving
c) Your roommate earns $100 and deposits it in his account at a bank.
Saving
d) You borrow $1,000 from a bank to buy a car to use in your pizza delivery business.
Investment

Question 2: Suppose GDP is $8 trillion, taxes are $1.5 trillion, private saving is $0.5 trillion,
an public saving is $0.2 trillion. Assuming this economy is closed, calculate consumption,
government purchases, national saving, and investment.

Y=C+I+G
Sprivate = Y – T – C = 0.5 trillion
Spublic = T – G = 0.2 trillion
T = 1.5 trillion
Y = 8 trillion
- Consumption
Sprivate = Y – T – C = 0.5 trillion
5 – 1.5 – C = 0.5
C = 8 – 1.5 – 0.5 = 6 trillion
- Government purchases
Spublic = T – G = 0.2 trillion
1.5 – G = 0.2
G = 1.5 – 0.2 = 1.3
- national saving
Snational = Sprivate + Spublic = 0.5 + 0.2 = 0.7
- investment
I = S = 0.7 trillion
Or Y = C + I + G => I = Y – C – G => I = 5 – 3 – 1.3 = 0.7 trillion

Question 3: saving and investment in the macroeconomic equation: Investment and Savings
equations are the following:
 I = 100 − 500i
S = 0,25Y − 40

1) What is the level of investment when the interest rate is respectively 4%, 5%, 6%?

𝐼 = 100 − 500𝑖

For i = 4% , 𝐼 = 100 − 500 (0.04), I = 80

For i = 5%, 𝐼 = 100 − 500 (0.05), I =75
For i = 6%, 𝐼 = 100 − 500 (0.06), I = 70

2) Calculate the equilibrium income at the level of investment you have just determined.
In equilibrium state, I = S. Therefore, the equilibrium

0, 25 Y – 40 = 80, thus Y = 480

0,25 Y – 40 = 75, thus Y = 460
0,25 Y – 40 = 70, thus Y = 440
OR., if you would like to compute the equilibrium income in more details.
You will say,
In equilibrium, I =S
Thus,

I = 100 − 500i
S = 0,25Y − 40
100 − 500 𝑖 = 0, 25 Y – 40

0, 25 Y = 140 – 500 i
140 500
Y = 0.25 – 0.25 i

So, for 4%, 5% and 6%, Y are

140 500
Y = 0.25 – 0.25 (0.04) = 480
140 500
Y = 0.25 – 0.25 (0.05) = 460
140 500
Y= – (0.06) = 440
0.25 0.25

3) Plot these points in space (Y, i) and give an intuitive interpretation of the resulting curve

Interpret the fact that if "i" is increasing, investment fall as is more costly (expensive) ; we
can say that this curve will be called IS then
Interest rate (i)

6
5
4%
Y
440 460 480

Question 4: Economists in X-land, a closed economy, have collected the following information
about the economy for a particular year:
Y = 10,000
C = 6,000
T = 1,500
G = 1,700
The economists also estimate that the investment function is:
𝐼 = 3,300 − 100𝑟,
where r is the country’s real interest rate, expressed as a percentage.

Calculate private saving, public saving, national saving, investment, and the equilibrium real
interest rate.

- Private saving = Y - C - T = 10,000 - 6,000 - 1,500 = 2,500

- Public saving = T - G = 1,500 - 1,700 = -200

- National saving = Private saving + Public saving = 2,500 - 200 = 2,300

- Investment = savings
= 2300

- The equilibrium real interest rates

2,300 = 3,300 - 100r
3300 - 2,300 = 100r
1000 = 100 r
→ r = 10
Equilibrium real interest rate: 10%