Answer to Question #98586 in Macroeconomics for rabia

Question

The two scenarios from this exercise were: 1. Consumers save the full proceeds of the tax cut. 2. Consumers save 1/4 of the tax cut and spend the other 3/4. Which of these two scenarios do you think is more realistic? Why is this question important?
In both scenarios, public saving falls by $200 billion, and the budget deficit rises from $300 billion to $500 billion. 1. If consumers save the full $200 billion, national saving is unchanged, so investment is unchanged. 2. If consumers save $50 billion and spend $150 billion, then national saving and investment each fall by $150 billion. Prove it numerically.

Answer 1

1.

Which of these two scenarios do you think is more realistic?

whether the population will consume or save depends on the trends in the economy and on the expectations of the population. If the population expects a jump in inflation - most likely people will prefer to make large purchases. If stability is expected, they will prefer to save.

In my opinionthe more realistic scenario is - Consumers save 1/4 of the tax cut and spend the other 3/4. as this is more in line with rule 80/20 (Pareto principle)

Why is this question important? 

To establish macroeconomic equilibrium, an important condition is the equality of investment and savings.

2.

If consumers save the full $200 billion, national saving is unchanged, so investment is unchanged. 

If consumers save $50 billion and spend $150 billion, then national saving and investment each fall by $150 billion.

In macroeconomic equilibrium, there is equality of investment and savings.

If consumers save $50 billion (not 200 billion), then saving would decrease by 200-50 = 150 billion

investment = savings

so, investment would decrease by 150 billion too

https://www.investopedia.com/terms/p/paretoprinciple.asp