Consumption, Savings, and Investment: Goods Market Equilibrium

Question 1

What is the consumption function?

Answer 1

C = f(Y)
C = C’ + a*Y

Question 2

What is the equation for Investment?

Answer 2

I(t) = d*Kt + (Kt-1 - Kt)
Gross investment = Depreciation + Net investment

Question 3

What are the two important points of investment in macroeconomis?

Answer 3

i) Investment fluctuates more than Consumption and Government spending, explaining short-term business cycle
ii) Investment affects the long-run economic growth

Question 4

What is the optimal level of investment?

Answer 4

This is determined by the marginal cost and marginal benefit of capital
User cost of K = (r+d)*K

Assuming a diminishing MPk and d=0
=> Optimal k is when MPk = r
As r rises, the optimal k decreases

Question 5

What is the fiscal multiplier?

Answer 5

It measures the effect of a change in government spending on the overall economy

Question 6

Derive the fiscal multiplier

Answer 6

Y = C + I +G
C = C’ + a*(Y-T)

Y = C’ + a(Y-T) + I + G
(1-a)Y = C’ + aT + I + G
Y = C’/(1-a) + (a/1-a)T + (1/1-a)(I+G)
Changes in each side of the equality
dY = 1/(1-a) * dG
dY/dG = 1/(1-a) => Fiscal multiplier

Question 7

What is the Goods Market Equilibrium equation?

Answer 7

Goods market equilibrium = C + Id + G