Answer to Question #194239 in Macroeconomics for Selma Shilongo

Question

A closed economy was observed in two different years to be operating with levels of

output at: (a) aggregate supply was equal aggregate demand for goods and services but

planned domestic investment was greater than planned domestic saving ( b) aggregate

supply was equal aggregate demand for goods and service but planned domestic

investment was less than planned domestic saving. Use a diagram to explain the forces

that would move the economy towards a stable equilibrium in each case.

( 10)

Answer 1

In a closed economy, there is no activity of trading with outside economies. This economy is considered self-sufficient entirely, which means no exports leave the nation and no imports enter the nation.

(a)

The I {investment} and S {saving} curves intersect at point E Where Y2 is the equilibrium income level. It is shown in the diagram that if the level of income is Y1, planned domestic investment was greater than planned domestic saving. As a result, the income level will increase due to higher investment and at higher income levels more will be saved. Therefore, with the rise in income to Y2, saving rises and it becomes equal to I and hence, stable equilibrium.

(b)

The I and S curves intersect at point E Where Y2 is the equilibrium income level. It is shown in the diagram that if the level of income is Y3, planned domestic investment is < (less) than planned domestic saving. As a result, the income level will decrease due to lower investment and at lower income levels less will be saved. Therefore, with the decline in income to Y2, saving falls down and it becomes equal to I and hence, stable equilibrium.