Chapter 17: Problem 2

Assume an economy has a budget surplus of $1,000,$ private savings of $4,000,$ and investment of 5,000 . a. Write out a national saving and investment identity for this economy. b. What will be the balance of trade in this economy? c. If the budget surplus changes to a budget deficit of $1000,$ with private saving and investment unchanged, what is the new balance of trade in this economy?

Short Answer

Expert verified

a. The national saving and investment identity for this economy is: S = Sp + Ps = I, where S is national savings, Sp is private savings, Ps is public savings or budget surplus, and I is investment. b. The balance of trade in this economy is zero since S = I ($5,000 = $5,000). c. With a budget deficit of $1,000 and unchanged private savings and investment, the new national savings is $3,000 (S = Sp - |Ps|). As a result, the new balance of trade is -$2,000, representing a trade deficit (Balance of Trade = National Savings - Investment).

Step by step solution

Write the national saving and investment identity

To write the national saving and investment identity for this economy, we can use the following formula: National Savings (S) = Private Savings (Sp) + Budget Surplus or Public Savings (Ps) = Investment (I) We are given that Budget Surplus (Ps) = $1,000, Private Savings (Sp) = $4,000, and Investment (I) = $5,000.

Calculate national savings

Plug in the values from the given information into the national saving and investment identity: S = Sp + Ps S = $4,000 + $1,000 S = $5,000

Determine the balance of trade

The balance of trade depends on the relationship between national savings and investment. Since national savings is equal to $5,000 and investment is also equal to $5,000, the balance of trade is zero. This means that the economy has neither a trade surplus nor a deficit.

Change in budget surplus

The exercise mentions that the budget surplus changes to a budget deficit of $1,000 while keeping private savings and investment unchanged. We need to recalculate the national savings and determine the new balance of trade.

Calculate the new national savings with the budget deficit

Now that we have a budget deficit instead of a surplus, the national saving and investment identity becomes: S = Sp - |Ps| S = $4,000 - $1,000 S = $3,000

Determine the new balance of trade

With the new national savings equal to $3,000 and investment still at $5,000, we have S < I. Therefore, the economy now has a trade deficit. To calculate the new balance of trade, we can use the following formula: Balance of Trade = National Savings - Investment Balance of Trade = $3,000 - $5,000 Balance of Trade = -$2,000 So, the new balance of trade in this economy is -$2,000, which represents a trade deficit.