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What are the substitution effect and income effect associated with an increase in interest rate 
on saving deposits? Show and explain on a diagram a case where the savings of a household 
remain same after an increase in the interest rate of saving deposit

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Related questions

Assume that consumption when young and consumption when old are both normal goods. The income effect of an increase in the interest rate will result in:

  a.

a decrease in saving when young.
  b.

a decrease in saving when old.
  c.

an increase in saving when old.
  d.

an increase in saving when young.

In the class, we discussed the Paradox of Thrift argued by John Maynard Keynes. According to the argument, even if many household decide at the same time to increase their saving, the total saving will not increase in the long run, while it leads the economy to a recession. For example,

case1: Income = N, MPC = ?, MPS = ?. case2: Income = N, MPC = ??, MPS = ?? where?? >?and0<?,?,??,?? <1.

Even though household decide to save more in case 2, the total saving in the long run will be same in the both cases.

(Question) Prove that the total saving in the long run in case 1 equals to that in case 2.

-At this time, I recommend you to solve this question theoretically using N, ?, ?, ??, ?? rather than using specific number such as 0.8 or 0.9.

-Hint: Use the concept of multiplier effect covered in the class.

Consider two different models of the loanable funds market. In model A saving does not depend on the interest rate (as it is the case in the model covered during lecture). In model B as the real interest rate increases, so does saving. That is, national saving is a positive function of the real interest rate. What would be the effect of a reduction in the investment tax credit on investment and the real interest rate in model A? What will be the effect on model B? Explain.

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