Macroeconomics 5th Edition by Olivier Blanchard

Exercise 6

The paradox of saving, one more time
In chapter problems at the end of Chapters 3 and 5, we examined the paradox of saving in the short run, under different assumptions about the response of investment to output and the interest rate. Here we consider the issue one last time in the context of the AS-AD model.
Suppose the economy begins with output equal to its natural level. Then there is a decrease in consumer confidence as households attempt to increase their saving for a given level of disposable income.
a. In AS-AD and IS-LM diagrams, show the effects of the decline in consumer confidence in the short run and the medium run. Explain why the curves shift in your diagrams.
b. What happens to output, the interest rate, and the price level in the short run What happens to consumption, investment, and private saving in the short run Is it possible that the decline in consumer confidence will actually lead to a fall in private saving in the short run
c. Repeat part (b) for the medium run. Is there any paradox of saving in the medium run