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Chapter 23: Problem 14

If domestic investment increases, and there is no change in the amount of private and public saving, what must happen to the size of the trade deficit?

Short Answer

Expert verified
In conclusion, when domestic investment increases and there is no change in private and public saving, the size of the trade deficit must widen. This indicates a higher dependence on imported goods and potentially a consumption of domestic savings or foreign borrowing to finance the increase in domestic investment.

Step by step solution

01

Understand the National Income Identity Equation

The National Income Identity Equation is given by: \(GDP = C + I + G + NX\) where: - GDP: Gross Domestic Product (the market value of all final goods and services produced within a country in a given period) - C: Consumption (total spending by households) - I: Domestic Investment (spending on new capital goods) - G: Government Spending - NX: Net Exports (Exports - Imports, also known as trade balance) For our problem, we are interested in understanding the relationship between Domestic Investment (I), private and public saving, and the trade deficit which can be represented as: \(S - I = NX\) where S represents the total saving in the economy (private and public saving combined).
02

Analyze the Effect of an Increase in Domestic Investment

Now, let's analyze what happens when there is an increase in domestic investment (I), while private and public saving (S) remains the same. In this case, the equation becomes: \(S - (I + ΔI) = NX'\) where ΔI is the increase in domestic investment. Since S remains the same, if I increases, the difference between S and I will decrease. Therefore, the right-hand side of the equation (NX') must also decrease.
03

Conclusion

When domestic investment increases and there is no change in private and public saving, the size of the trade deficit (or trade balance) represented by NX must also decrease. A decrease in the trade balance means that the trade deficit is widening, reflecting a higher dependence on imported goods and potentially a consumption of domestic savings or foreign borrowing to finance the increase in domestic investment.

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Most popular questions from this chapter

Does a trade surplus mean an overall inflow of financial capital to an economy, or an overall outflow of financial capital? What about a trade deficit?

In recent decades, has the U.S. trade balance usually been in deficit, surplus, or balanced?

In 2001, the United Kingdom's economy exported goods worth \(£ 192\) billion and services worth another E77 billion. It imported goods worth \(£ 225\) billion and services worth \(£ 66\) billion. Receipts of income from abroad were \(£ 140\) billion while income payments going abroad were \(£ 131\) billion. Government transfers from the United Kingdom to the rest of the world were \(£ 23\) billion, while various U.K government agencies received payments of \(£ 16\) billion from the rest of the world. a. Calculate the U.K. merchandise trade deficit for 2001. b. Calculate the current account balance for 2001 . c. Explain how you decided whether payments on foreign investment and government transfers counted on the positive or the negative side of the current account balance for the United Kingdom in 2001.

What three factors will determine whether a nation has a higher or lower share of trade relative to its GDP?

Imagine that the economy of Germany finds itself in the following situation: the government budget has a surplus of \(1 \%\) of Germany's GDP; private savings is 20\% of GDP; and physical investment is 18\% of GDP. a. Based on the national saving and investment identity, what is the current account balance? b. If the government budget surplus falls to zero, how will this affect the current account balance?
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