Question

1. The national income identity for an open economy economy is given as Y = C + I + G + EX − IMwhere Y is real GDP; C is consumption, I is investment, G is government expenditure, EX is exports and IM is imports.

   (a) List the types of types of purchases that are included in C (5 points) (b) What does I include? (3 points)

   (c) Explain why G is most likely much less than the actual government outlays (2 points) (d) Explain why we add EX and deduct IM ( 3 points)

Answer 1

(a) The following types of purchases are included in the C:

• durable goods: purchase of all the durable goods in the economy is included in the C. the durable goods include automobiles, TV., Fridge and furniture etc.      
• non – durable goods: the purchase of non – durable goods such as food is included in the C
• services: purchase of all types of services in the economy is included in the C

(b)    I includes different types of investments made in the process of production in the economy the investments are as follows:

• residential investment: the investment which is done for the creation of residential structures and other residential works which helps in production process
• non – residential investment for the capital creation to increase economic activity.
• Inventory investment it is the change in stock due to the investment.

(c) G is most likely much less than the actual government outlays because the actual government outlays includes more spending than the G the G does not include social security benefits or transfer payments but it will be calculated in the actual government outlays.

(d) we add EX because it leads to increase in the production and also brings inflow of capital in the economy which increases GDP while IM decreases the production in domestic markets and leads to outflow of capital in the so we add EX and deduct IM.