Question

“In an economy, ex-ante investment (I) exceeds ex-ante savings (S).”
Explain the likely impact of the given situation on output, employment and income.

Hint:

When investment exceeds saving, income and employment rise due to the multiplier effect until saving equals investment again.

Answer 1

When planned investment (ex-ante investment) exceeds planned savings (ex-ante saving), it implies that the economy is facing a situation of excess demand. This situation triggers a series of positive effects on the economy:
Rise in Aggregate Demand: More investment leads to increased spending and demand for goods and services. Producers respond by increasing output.
Increase in Output and Income: Firms expand production to meet the growing demand. This leads to increased output and hence, increased income for households.
Employment Generation: With rising output, the demand for labor increases, creating more jobs and reducing unemployment.
Multiplier Effect: The initial increase in investment sets off a multiplier effect, where successive rounds of income and consumption lead to further increases in demand, output, and employment.
Equilibrium Restoration: As income rises, savings also increase. Eventually, savings rise enough to match the higher level of investment, bringing the economy back to equilibrium.
Thus, when ex-ante investment exceeds ex-ante savings, it causes a cumulative rise in output, income, and employment until a new equilibrium is achieved.