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AGovernment in the Solow growth model 1Why is the equilibrium condition now sp sg I We work with following assumptions 1 Closed economy with national income accounts identity Y C I G 2 All savings are invested Before the introduction of tax all of the consumers savings represent the total Investment The introduction of tax reduces the net income of the private sector and flows to the government What is not spent by the government will be saved and is therefore part of the investment Gov-ernment and consumer savings represent now the total investment Replacing taxes with gov-ernment consumption and government savings leads to the new equation for output which con-sists of private consumption private savings government consumption and government sav-ings Consumption is the total of private consumption and government consumption Replacing the basic equation with the calculated figures leads us to the result of isgsp Below are the equations shown for this solution FormulasFigures as an example y c I y cp tax sp tax cg sg y cp cg sg sp c cp cg cp cg i cp cg sg sp i sg sp10000 7000 3000 10000 5000 3000 2000 3000 2000 1000 10000 5000 1000 1000 3000 7000 5000 2000 5000 2000 3000 5000 2000 1000 2000 3000 1000 2000 Shown in the diagram below is that taxes reduce private consumption and savings making them government consumption and government savings Total investments are made up of private savings and government savings Output total Investment total Intuitively all that matters is how the governments uses the tax revenues saving or consump-tion Total savings
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