Suppose the long run equilibrium for a closed economy is described by model below: Y = 500 C = 250 - 10r G = 200 T = 210 I = 200 - 20r where Y is real (potential) GDP, C is consumption, G is government spending, T is taxes net of transfers, I is investment, and r represents the real interest rate in percentage points (eg. 10% is represented by 10)
(a) Derive an expression for private saving, a value for government saving, and an expression for national saving.
(b) Calculate the equilibrium interest rate and level of investment in the economy. Illustrate in a diagram.
(c) Suppose the government institutes a revenue-neutral tax reform that favours saving over consumption such that the new expression for consumption becomes: C = 240 - 15r. Re-solve to determine the new equilibrium interest rate and level of investment. Illustrate in your diagram.
(d) With reference to an aggregate production function, explain why the policy change described above might affect future economic growth.