Find The Equilibrium Interest Rate Assignment Paper

Posted on February 20, 2023

Find The Equilibrium Interest Rate Assignment Paper

2. (10) Consider an economy described as follows:  This economy is currently experiencing a budget deficit equal to 400 . a. In this economy, compute public saving, private saving, and national saving. b. Find the equilibrium interest rate. c. Suppose this country’s legislature passes a balanced budget amendment requiring government spending to equal net taxes. Find the new equilibrium interest rate under each of the following two options: a. Option I: Balance the budget by changing taxes b. Option II: Balance the budget by changing government spending Under which option will real interest rates be higher, and investment lower? Find The Equilibrium Interest Rate Assignment Paper

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Step-by-step

step 1

a. Public saving is defined as the difference between government revenue (net taxes) and government spending, so in this case, public saving is:
����=�−�=0−3,000=−3,000
Private saving is defined as the difference between disposable income and consumption, so in this case, private saving is:
����=(�−�)−�=(14,000−0.2�)−(1,000+0.8(�−�))=0.2�−�−1,000=0.2(14,000)−0−1,000=1,800
National saving is the sum of public and private saving, so in this case, national saving is:
����=����+����=−3,000+1,800=−1,200
b. To find the equilibrium interest rate, we need to set national saving equal to investment:
����=�
Substituting the given expressions for national saving and investment, we get:
−1,200=1,900−70�
Solving for r, we get:
�=1,900+1,20070=43.14
So the equilibrium interest rate is 43.14%
  • Explanation for step 1
Complete solution of question a and b

step 2

c. Under a balanced budget amendment where government spending equals net taxes, we have:
�=�
Option I: Balance the budget by changing taxes If the government balances the budget by changing taxes, net taxes (T) will have to increase by 400 to eliminate the deficit. So we have: Find The Equilibrium Interest Rate Assignment Paper
�=�+����=3,000−400=2,600
This will increase private saving, but not affect national saving. The expression for private saving becomes:
����=(�−�)−�=(14,000−0.2�)−(1,000+0.8(�−�))=0.2�−�−1,000=0.2(14,000)−2,600−1,000=1,200
To find the new equilibrium interest rate, we again set national saving equal to investment:
����=�
Substituting the given expressions for national saving and investment, we get:
1,200=1,900−70�
Solving for r, we get:
�=1,900−1,20070=11.43
So the new equilibrium interest rate is 11.43%.
Option II: Balance the budget by changing government spending If the government balances the budget by changing government spending, it will have to decrease spending by 400 to eliminate the deficit. So we have:
�=�=2,600
This will not affect private saving, but will increase public saving. The new expressions for public and national saving are: Find The Equilibrium Interest Rate Assignment Paper
����=�−�=0
����=����+����=0+1,800=1,800
To find the new equilibrium interest rate, we again set national saving equal to investment:

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����=�
Substituting the given expressions for national saving and investment, we get:
1,800=1,900−70�
Solving for r, we get:
�=1,900−1,80070=1.43
So the new equilibrium interest rate is 1.43%.
Option II will have a lower real interest rate and investment, as a decrease in government spending leads to an increase in public
  • Explanation for step 2
Complete solution of part c

Find The Equilibrium Interest Rate Assignment Paper

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