If government spending (G) becomes negatively sensitive to changes in the interest rate, what effect does this have on autonomous consumption and planned investment that is crowded out? If autonomous taxes (Ta) become positively sensitive to changes in the interest rate, what effect does this have on the amount of autonomous consumption and planned investment that is crowded out?
Do a little research, then take a shot. What do you think?
Hint: draw IS and LM curves. What would the IS curve look (or how would it shift) if G was inversely related to r.)
To answer these questions, let's break down each scenario separately:
Scenario 1: Government Spending (G) becomes negatively sensitive to changes in the interest rate.
When government spending becomes negatively sensitive to changes in the interest rate, it means that as the interest rate increases, government spending decreases. This has implications for autonomous consumption and planned investment.
Autonomous consumption refers to the minimum level of consumption that occurs regardless of income or other factors. Planned investment refers to the amount of investment that businesses intend to make.
When government spending decreases due to an increase in the interest rate, it may lead to a decrease in overall demand in the economy. This decrease in demand can have a crowding-out effect on both autonomous consumption and planned investment.
Autonomous consumption may decrease because the reduction in government spending leads to reduced income for individuals or households, which in turn affects their ability and willingness to consume.
Planned investment may also be crowded out because the decrease in demand and economic activity can make businesses less optimistic about the future profitability of their investments, leading them to reduce their investment plans.
Scenario 2: Autonomous Taxes (Ta) become positively sensitive to changes in the interest rate.
When autonomous taxes become positively sensitive to changes in the interest rate, it means that as the interest rate increases, autonomous taxes also increase. This has implications for autonomous consumption and planned investment.
Similar to the previous scenario, an increase in autonomous taxes can have a crowding-out effect on autonomous consumption and planned investment.
An increase in autonomous taxes reduces disposable income, which affects autonomous consumption. Disposable income is the income available for consumption after taxes have been deducted. With higher autonomous taxes, individuals have less disposable income, which can lead to a decrease in autonomous consumption.
Higher autonomous taxes can also impact planned investment. With less disposable income, individuals and businesses have less money available to invest. This reduction in investment can occur through either a decrease in business investment or a decrease in personal savings available for investment.
In summary, when government spending becomes negatively sensitive to changes in the interest rate, it can lead to a decrease in autonomous consumption and planned investment. Similarly, when autonomous taxes become positively sensitive to changes in the interest rate, it can also result in a decrease in autonomous consumption and planned investment due to reduced disposable income.