Question

3. Saving and net flows of capital and goods

In a closed economy, saving and gross investment must be equal, but this is not the case in an open economy. In the following problem, you will explore how saving and gross investment are connected to the international flow of capital and goods in an economy. Before delving into the relationship between these various components of an economy, you will be asked to recall some relationships between aggregate variables that will be useful in your analysis.

Recall the components that make up GDP. National income (Y) equals total expenditure on the economy’s output of goods and services. Thus, where C = consumption, I = gross investment, G = government spending, and NX = net exports, Y is defined as follows:

Y = (C - I + G + NX) / (C + I + G - NX) / (C + I + G + NX) / C + I - G - NX) PICK ONE

National saving (S) is the income of the nation that is left after paying for government spending and consumption. Therefore, S is defined as follows:

S = (Y - C) / (Y - I - C) / (Y - C - G) / (Y - I) PICK ONE

Rearranging the previous equation and solving for Y yields Y = (S + I) / (S + I + C) / (S + C + G) / (S + C) PICK ONE

Plugging this into the original equation showing the various components of income results in the following relationship:

S = (I + G + NX) / (I + NX) / (C + G + NX) / (G + NX) PICK ONE

This is equivalent to S = (G + NCO) / (C + G + NCO) / (I + NCO) / (I + G + NCO) PICK ONE

since net exports must equal net capital outflow (NCO, also known as net foreign investment).

Now suppose that a country is experiencing a trade deficit. Determine the relationships between the entries in the following table and enter these relationships using the following symbols: > (greater than), < (less than), or = (equal to).

Outcomes of a trade deficit [pick one for each bracket]

Net Exports [ < , = , >] 0

Imports [ <, =, >] Exports

C + I + G [<, =, >] Y

Gross Investment [<, =, >] Saving

0 [<, =, >] Net Capital Outflow

Answer 1

National income (Y) includes total expenditure on economy's production of several goods and service. Y includes consumption expenditure (C) , government spending (G), net exports (NX) and gross investment (I). So, Y=C+I+G+NX

National Savings (S) is the income of nation left after paying for consumption and government spending.

So, S=Y-C-G. Rearranging S=Y-C-G gives Y=S+C+G.

Putting Y=S+C+G in Y=C+I+G+NX imply:

S+C+G=C+I+G+NX

S=C+I+G+NX-C-G

S=I+NX ------------------------- equation 1

As net exports (NX) must equate net capital outflow (NCO), equation 1 can be written as------------

S=I+NCO

With trade deficit:

Net exports is lesser than (<) 0 as net exports represents Exports minus Imports and with trade deficit imports are greater than exports implying net exports is lesser than 0. Imports are greater (>) than exports with trade deficit. C+I+G is > Y as this equation can be written in the form I+G>Y-C or I+G>S which imply domestic gross investment is higher than savings with trade deficit as people are spending more on foreign capital or goods and services. Gross Investment > than Savings as people as more capital flowing in the country from foreign countries. This also imply Net capital Outflow is < than 0.