Question

Given the consumption function, planned investment, government spending, exports, and imports, what is equilibrium income, government deficit, and account current balance?

a) $420, $50, $75
b) $480, $60, $50
c) $520, $40, $25
d) $460, $70, $100

Answer 1

Equilibrium income is determined by the equality of aggregate expenditure and total output, incorporating consumption, investment, government spending, and net exports. The current account balance reflects the difference between national saving and domestic investment. In the given scenario, the national saving and investment identity indicates a current account deficit that increases when investment increases.

Step-by-step explanation:

Finding the Equilibrium Income, Government Deficit, and Current Account Balance

When determining the equilibrium income in the Keynesian model, one must account for all components of the aggregate expenditure: consumption, investment, government spending, net exports (exports minus imports), and in this case, taxes and the marginal propensity to save. The consumption function can be established from the autonomous consumption and the marginal propensity to consume, which is implied to be the remainder after accounting for taxes and the marginal propensity to save. In the scenario provided, investment is $70, government spending is $80, and exports are $50. Assuming no imports and taxes, which are 20% of the real GDP, the equilibrium is reached when the aggregate expenditure equals the total output or income.

To assess the government deficit and current account balance, we refer to the national saving and investment identity. If the government's budget deficit is $100 billion, domestic savings are $1,500 billion, and domestic investment is $1,600 billion, the current account balance would be equal to the excess of national saving over domestic investment — which is -$100 billion (since national saving is $1,500 billion minus the deficit of $100 billion equals $1,400 billion, and investment is $1,600 billion, resulting in a current account deficit).

When investment rises by $50 billion while the government deficit and national savings stay the same, the current account deficit increases by that amount, becoming -$150 billion ($1,400 billion in national saving minus $1,650 billion in investment).