Finance & Accounting
Pages 8 (2008 words)
Investment in an uncertain world Part A. Part A (50 per cent of the marks) 1a. Consider a closed economy with households, firms and a government sector, where total current government expenditure is equal to total current revenue (from taxation). Table 1 reports data from the economy’s national accounts: (i) Calculate public expenditure as a percentage of GDP.?
10,000,000 = 6,000,000 + 1,000,000 + G G = 10,000,000 – 6,000,000 – 1,000,000 = G = 3,000,000 G as a percentage of GDP = (G divided by Y) and multiplied by 100. =(3,000,000/10,000,000) *100 = = 30 per cent. (ii) Calculate households’ savings as a percentage of GDP. Explain your calculations. (6 marks) In this situation, Y = C + I + G (Savings = Investment = Gross Capital Formation) Therefore, Y = C + S + G. And S as the percentage of Y = (S/Y)* 100 = (1,000,000/10,000,000) *100 = = 0.10 * 100 = 10 per cent Therefore, households’ savings are 10 per cent of GDP. 1b. Now imagine an unexpected shock to the economy (not predicted by the majority of economists and other experts), which hits households’ confidence so that they increase their savings until these amount to 25 per cent of GDP. (i) Under Say’s Law, what is the mechanism by which firms’ investment is expected to change and what will its new value be? J. B. Say, a French classical economist, says supply creates its own demand until the equilibrium between the two is reached. By extension, Say’s law also applies to money market. When there is a glut of savings, there will be more supply of money than demand. As a result, interest rate for borrowing will come down and investment will increase. ...