Chapter 9: Problem 12

If a country is running a government budget surplus, why is (\(\mathrm{T}-\mathrm{G}\)) on the left side of the saving-investment identity?

Short Answer

Expert verified

In a closed economy, the saving-investment identity states that the total savings (private savings by households and businesses, plus public savings by the government) should be equal to the total investment. The government budget surplus (\(\mathrm{T}-\mathrm{G}\)), where T represents tax revenues and G represents government expenditures, forms part of the total savings and thus appears on the left side of the saving-investment identity. This is because the government's surplus accounts for its public savings, and in a closed economy, total savings must equal total investment.

Step by step solution

Government Budget Surplus

A government budget surplus occurs when the government's tax revenues (T) are greater than its expenditures (G). In other words, a surplus exists when the government collects more money from taxes than it spends. Mathematically, this can be expressed as follows: Government Budget Surplus = \(\mathrm{T}-\mathrm{G}\), where T > G

Saving-Investment Identity

The saving-investment identity states that in a closed economy, the total amount of savings (S) should be equal to the total amount of investment (I). This can be mathematically expressed as: S = I In a closed economy, savings come from two sources: private savings by households and businesses, and public savings by the government. To include the government's contribution to the total savings, we can rewrite the identity as: Private Savings + Public Savings = Investment

Public Savings and the Saving-Investment Identity

Public savings represent the government's budget surplus, which is the difference between tax revenues and government expenditures. We can represent public savings as: Public Savings = \(\mathrm{T}-\mathrm{G}\) To complete the saving-investment identity, we will substitute this expression for public savings: Private Savings + (\(\mathrm{T}-\mathrm{G}\)) = Investment

Final Saving-Investment Identity

With the public savings term included, we have the completed saving-investment identity: Private Savings + (\(\mathrm{T}-\mathrm{G}\)) = Investment This identity shows that the government budget surplus (\(\mathrm{T}-\mathrm{G}\)) is on the left side of the equation. In a closed economy, it forms part of the total savings, which must be equal to the total investment. Now we have clarified why the term (\(\mathrm{T}-\mathrm{G}\)) is on the left side of the saving-investment identity. It represents the government's contribution to total savings in a closed economy, which must equal the total amount of investment.

Unlock Step-by-Step Solutions & Ace Your Exams!

Full Textbook Solutions
Get detailed explanations and key concepts
Unlimited Al creation
Al flashcards, explanations, exams and more...
Ads-free access
To over 500 millions flashcards
Money-back guarantee
We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!