Answer to Question #195621 in Macroeconomics for Jusment

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.

Answer 1

(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.