Answer to Question #113327 in Macroeconomics for Yahiya

Question

Explain the relationship between output, saving, and investment. Explain what condition
must occur for each of the following to occur: (1) the capital stock to increase; (2) the capital
stock to decrease; and (3) the capital stock to remain constant with aid of a diagram.

Answer 1

Answer is: Output is the combination of consumption and investment. The demand for goods is the combination of consumption and investment. It implies that output per worker is the sum of consumption per worker and investment per worker.

Y= C+I

And the fraction that people don’t consume, this will be called saving.

C= (1-s) y (where s is the savings rate).

Now, by substituting this into its equation, we get,

Y= ( 1-s ) y+i

I= sy (where I is investment and sy is savings).

Therefore, the relationship between output, savings and investment tells about the equilibrium position.

1.      For capital stock to increase, investment must be larger than savings.

2.      For capital stock to decrease, savings must be larger than investment.

3.      For capital stock to remain constant, investment has to be equal to savings (i=sy).