Your assignment is to prepare and submit a paper on the introduction to macroeconomics, bubbles, and investment behaviour in part three of the module, bubbles and the economy. Therefore, the accounting identity can also be explained as:
As shown in the above graph, the savings (s) in a closed economy is always given exogenously. The investment in the market (I) is a function of rate of interest (r). The cost of borrowing money in an economy becomes high when the lending rate of interest is elevated. Hence, investments made in the market are adversely related to the lending rate of interest. At equilibrium rate of interest (re), national savings and investment remains equal to each other (S=I) (Baddeley, 2005).
When the aggregate savings in an economy rise up to 30% of GDP, the investments can be expected to increase (to match savings) only if the lending rate of interest (r) falls below the previous equilibrium rate (re).
(ii) The supply side policies are implemented in an economy for increasing productivity of its real national output, during a state of recession. These policies help an economy to grow sustainably, without the persistence of inflation (Bernanke, Gertler and Gilchrist, 1996). However, economic growth cannot be successfully achieved solely with the essence of supply side policies. The supply side approach is rendered successful with presence of adequate aggregate demand in the economy. If the housing confidence slumps and the economy suffers from recession, then the individuals desire to save more and spend less. As a result, if the monetary authorities of a country lower interest rate and stimulate investments, then aggregate production related activities will rise, but the output produced will not be sold adequately due to lack of consumers’ demand (Mankiw and Taylor, 2006).
(iii) The problems associated with a supply side approach can be resolved with the help of expansionary fiscal policies. These policies will enable the government authorities to stimulate the level of aggregate demand.