Question

1. A. Derive and explain the national income identity for an open economy. B. Does spending necessarily have to equal output in an open economy? C. Is there a relationship between a country’s national budget deficit and its trade deficit?

Answer 1

GDP is divided into 4 categories i.e. consumption (C) , investment(I), govt purchases(G) and net exports (X=exports -M=imports )

Y= C+I+G+(X-M) = national income identity

Here the consumption refers to household expenditure on various goods and services

Investment refers to the expenditure done by firms to purchase capital goods to produce consumer goods

Government purchases refers to purchases done by central, state and local governments over public utilities but transfer payments do not form the part of GDP

Net exports are the difference between exports and imports

National income = total expenditure (It means the expenditure done to generate income)

Y= C+I+G+X-M

Again Y= C+S+T ( It means use of income to spend, invest and give taxes)

Now the usage of income is equal to the source of generation of income, the equation would look like

C+S+T = C+I+G+X-M

Cancelling out C from both sides we get

S+T= .I+G+X-M

2 It is not necessarily required that a country’s spending in a given year be equal to its output of goods and services.It is possible when the government adopts to borrowing from foreign countries or lending to foreign country

3 National budget deficit or government fiscal deficit arise when the govt is spending more than what it's revenue source (taxes) are generating.

It might be either due to high government spending or low taxes

Trade deficit is when the Imports are more than the exports.

Budget deficit means that there will be need to inject liquidity which will spurt the Spending and thus increase the demand leading to inflation now there will be two effects... the rich will import more as a result of more spending power hence enlarging the trade deficit. But in other cases the budget deficit might be due to reduced consumer demand (like the current pandemic) or recession.