Question

The identity between national savings and investment holds only in a(n): open economy. closed economy. shrinking economy. growing economy.

Answer 1

In a closed economy AE = Aggregate expenditure = C + I + G where C = consumption , I = Investment and G = Government spending. Economy is in equilibrium when Y = AE where Y = Nation income.

Thus Ina closed economy, At equilibrium Y = AE = C + I + G => I = Y - C - G.

National Saving = Private saving + Public saving.

Private saving = Y - C - T where T = Taxes and Public saving = T - G

Thus, National saving = Y - C - T + T - G = Y - C - G.

Thus when Economy is closed then I = Y - C - G = National saving. Hence (b) is the correct answer.

Note in the Open economy AE = C + I + G + NX where NX = Net exports.

Thus in open economy at equilibrium Y = C + I + G + NX => I = Y - C - G - NX

=> I = National saving - NX.

Hence In open economy National Saving is not equal to Investment. Hence, open economy is incorrect.

Hence, the correct answer is (b) Closed economy.