a) Suppose that there is a permanent collapse in consumer confidence causing households to spend a smaller portion of their incomes on goods and services (i.e., consume less and save more). Use the IS-LM, AD-AS model to explain and illustrate the long-run effect of this on i, P, and Y. [Ignore the short run. Go right to the new long-run equilibrium.]
b) What happens to investment in the long run? How do you know? What will be the long-run effect of this change in saving/investment? That is, what will be the effect on K*/N and Y*/N? Explain and illustrate using the Solow model of chapters 10 and 11.
c) In what sense does this example illustrate a tradeoff between current consumption and future consumption?