Consider a closed economy in the long run.

C = 150 + 0.6 (Y-T) I = 300 - 10r G = 500 T = 250

And a natural rate of output of 1,750. Show savings and investment on a well labelled diagram with the real interest rate on the vertical axis. What happens to savings when the government deficit increases? You should solve for savings and label it correctly on your diagram. Solve for the equilibrium real interest rate, r. What share of expenditure goes to consumption, investment and government purchases? What is the debt to GDP ratio? Suppose that the government would like to balance its budget. There are two ways to do this: estment of balancing the budget in both cases. What role does the real interest rate play?