Goods Market [5 marks]

Explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy. Illustrate your answer using a saving-investment diagram with real interest rate on the vertical axis and saving/investment on the horizontal axis.Label the axes and curves clearly.

a) The tax code changes so that business firms face higher tax rates on their revenue (offset by other lump-sum tax changes so there's no overall change in tax revenue).[1.5 marks]

b) The average educational level rises, inducing an increase in the future marginal productivity of capital.[1.5 marks]

c) A temporary increase in government purchases for military purposes. Does it matter whether the temporary increase in military spending is funded by taxes or by borrowing?[2 marks]