Problem:
Assume that American households change their tastes such which they desire to save more at every level of income.
Required:
Question 1: With the help of the Keynesian cross diagram, describe the effect that this change in tastes will have on equilibrium level of output.
Question 2: Assume that the Fed employs open market operations to equalize the effect of change in saving on output. Illustrate what it should do to get output back to its original level. Will the composition of the demand be the same as it was originally? Discuss.
Question 3: Describe under what situations (more than one) the Fed’s policy would be unsuccessful. If monetary policy were ineffective, what would be the substitute? Describe your answer.