# Decrease in Government Spending on Savings and Investment

Please explain the likely effects on Savings (Gross Private Domestic) Investment, Long Term Real Interest Rates, The Capital Stock, Natural RGDP and Natural Per Capita RGDP of a decrease in Government Investment Spending (with no change in tax rates). Please explain this in about two pages double spaced, and include information in terms of I = S prime + (T-G) + (IM-X)

Also show this shift on an equilibrium type graph where the R 0, R 1, and R 2 are on the Y axis and I0, I1,I2 and S0, S1, S2 are on X axis.

https://brainmass.com/economics/supply-and-demand/decrease-government-spending-savings-investment-522842

#### Solution Preview

Please refer to the diagram where the demand for investment is Ir0 and the supply for investment is Sr0. The equilibrium point is E0. When the government reduces investment, the demand for investment decreases, and the demand curve for investment shifts to Ir1. The new equilibrium point is E1. When the equilibrium point was E0 the rate of interest was R0 and S0 was the savings/investment, at the new equilibrium point E1, the rate of interest is R1 and the S1 is the savings/investment level.

If there is a decrease in Government Investment spending with no change in tax rate the demand for investment moves to left. In the diagram the Ir0 moves to a new position Ir1. This movement leads to a new equilibrium at E1. At this equilibrium level both the rate of interest is low and savings investment is lower. The Long term real interest rates are also pushed lower because of the lower rates of interest. On the ...

#### Solution Summary

Change in government expenditure is analyzed in this response. The answer includes two references.

MPC, MPS, Multiplier

(See attached file for full problem description)

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HYPOTHETICAL INCOME DATA (BILLIONS OF DOLLARS)

(NET EXPORTS IS ASSUMED TO BE ZERO)

Y (GDP) C I G

$0 $100 $80 $60

100 175 80 60

200 250 80 60

300 325 80 60

400 400 80 60

QUESTIONS

1. What is the value of the MPC (marginal propensity to consume)?

2. What is the value of MPS (marginal propensity to save)?

3. What is the value of the:

a. government expenditure multiplier

b. investment expenditure multiplier

4. If the economy is in equilibrium at $960 billion, what is the level of Saving?

5. Assuming an equilibrium of $960 billion, what is the new equilibrium if government expenditures increase by $25 billion?

6. Assuming an equilibrium of $960 billion, what is the new equilibrium if a lump sum tax of $20 billion is imposed?

HINTS:

1. The multipliers for government expenditures (G), investment spending by businesses (I), and net exports (XN) all have the same value and are calculated as 1 divided by the MPS (marginal propensity to save).

2. There is a tax multiplier and its value is one less than the multiplier for government expenditures (G). Also, the tax multiplier has a negative sign, since increasing taxes decreases GDP (Y).

3. In equilibrium saving (S) is equal to investment spending by businesses (I) plus government expenditures (G). S = I + G.

4. An increase in government spending (G) or investment spending by businesses (I) raises equilibrium GDP (Y) by the amount of the increase times the multiplier.

5. A decrease in government spending (G) or investment spending by businesses (I) lowers equilibrium GDP (Y) by the amount of the decrease times the multiplier.

6. A lump sum tax decreases equilibrium GDP (Y) by the amount of the tax times the tax multiplier.

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