Chapter 11, Problem 1QAP

a)

To determine

To find: Whether saving rate is equal to investment is true, false or uncertain.

Explanation of Solution

According to Keynes,

At equilibrium $\text{Savings}\text{=}\text{Investment}$

This derivation is done when aggregate demand is equal to aggregate supply.

This will be shown in the following expression:

  $\begin{array}{l}Y=C+I\\ S=I\\ Y=Income\\ C=Consumption\\ I=Investment\\ S=Saving\end{array}$

Thus, the statement is true.

b)

To determine

To know:Whether higher investment rate can sustain higher growth of output is true, false or uncertain.

Explanation of Solution

The savings rate is equal to investment rate. A higher saving means an economy is not consuming its income but saving it for future. The saving in turns becomes an investment for business. So, higher investment will lead to higher growth of output. But in long run, when economy reaches its steady state, higher investment will not lead to higher growth of output. Instead, more investment will be used to compensate depreciating capital.

Thus, higher investment will cause growth for some time but once it hits its maximum it will no longer be a source of growth.

Thus, the statement is false.

c)

To determine

To know:Whether “If capital never depreciated, growth could go on forever” is true, false or uncertain.

Explanation of Solution

Depreciation is wear and tear of existing capital. This usually happens due to usage of capital stock. When capital never depreciates, it will lead to growth but not forever. This is because due to decreasing returns to scale, a stage will appear when output growth is less or negative compared to increase in capital stock It happens because, it is a saturation point for capital stock to be used.

Thus, the statement is false.

d)

To determine

To find:Whether given statement“The higher saving rate, the higher consumption in steady state” is true, false or uncertain.

Explanation of Solution

To determine whether increasing the savings rate would increase consumption one should know what the golden-rule level of capital is for an economy.

The golden-rule level of capital is the savings rate that is associated with the highest level of consumption in the steady state. If the savings rate is higher than the golden-rule level of capital, then increasing the savings rate would decrease consumption. Conversely, if the savings rate is lower than the golden-rule level of capital, then increasing the savings rate would increase consumption.

Thus, the statement is uncertain.

e)

To determine

Whether given statement one should transform Social Security from a pay-as-you-go system to a fully funded system this would increase consumption both now and, in the futureis true, false or uncertain.

Explanation of Solution

Fully funded system is a type of system in which government saves the amount of taxes as social security fund. Taxes are saved to give retirement benefits to the senior citizens. The shift to a fully loaded system decreases saving rate of an economy. This is because in fully loaded system, workers anticipate that after retirement, they will be given more incentives of being senior citizen. While in pay-as-you-go system, government spends the tax collection on current retired people. It implies there is no or less savings, as public savings are reduced.

Thus, the statement is uncertain.

f)

To determine

Whether given statement “the U.S. capital stock is far below the golden rule level. The government should give tax breaks for saving because the U.S. capital stock is far below the golden rule level” is true, false or uncertain.

Explanation of Solution

Currently, the country U savings rate is 17%. The savings rate associated with highest level of output is 50%. Almost assuredly if the United States increased its savings rate, consumption would increase as well. If a well-designed tax break increased the savings rate in the United States, consumption would likely increase as well. Thus, the statement is true.

g)

To determine

Whether given statement “Education increases human capital and thus output. It follows that governments should subsidize education” is true, false or uncertain.

Explanation of Solution

The evidence is unclear but actually suggests that if most people gained higher education, aggregate output would not increase much. If most people gained higher education, there would be a higher overqualified pool of job applicants and many people would consequently become frustrated. Although subsidizing education is uncertain, it likely should not be undertaken.

Thus, the statement is uncertain.