Question

The fictional country of Sendaria finds itself in the following situation: the government has a deficit of 2% GDP, private savings is 17% of GDP, and physical investments are 15% of GDP.

a)What is the trade balance?

b) If the government budget is set at zero, how will this affect the trade balance?

Question 1 options:

	a) Trade balance = 4%, b) Trade balance will DECREASE to 0%
	a) Trade balance = 0%, b) Trade balance will INCREASE to 2%
	a) Trade balance = 4%, b) Trade balance will INCREASE to 2%
	a) Trade balance = 0%, b) Trade balance will DECREASE to -2%

Answer 1

(a) (Saving-Investment relation in open economy)

(Government saving + Private saving) = (Investment + Trade balance.)

Divide both sides by GDP

=> (Govt. saving / GDP) + (Private saving / GDP) = (Investment / GDP) + (Trade Balance / GDP)

Given information:

(Govt. saving / GDP) = -2%

(Private saving / GDP) =17%

(Investment / GDP) = 15%

=> -2% + 17% = 15% + (Trade balance / GDP)

=> 15% = 15% + (Trade balance / GDP)

=> (Trade Balance / GDP) = 15% - 15%

=> (Trade Balance / GDP) = 0%.

Trade balance is 0%

(b) If government budget is set at zero.

(Govt. saving / GDP) = 0%

(Private saving / GDP) =17%

(Investment / GDP) = 15%

(Govt. saving / GDP) + (Private saving / GDP) = (Investment / GDP) + (Trade Balance / GDP)

=> 0% + 17% = 15% + (Trade Balance / GDP)

=> (Trade Balance / GDP) = 17% - 15%

=> (Trade Balance / GDP) = 2%

Trade balance will increase to 2%.

Answer: Option (B)