Question

In an economy, the output is 25, the consumption is 14, and

the government spends 6 and collects 5. The net exports are
positive
a. Find the equilibrium private savings.

Answer 1

The initial balance of trade in this economy is zero, meaning exports equal imports. When the budget surplus is replaced by an equal-sized deficit, the national saving decreases, resulting in a trade deficit of 2,000, where imports exceed exports.

Step-by-step explanation:

The question asks us to determine the balance of trade and changes in national saving and investment identities in a hypothetical economy. This involves understanding key economic concepts such as budget surpluses and deficits, private savings, national savings, investment, and the balance of trade. To solve for these, we apply certain economic identities and principles.

Finding the National Saving and Investment Identity

Firstly, we have to know that the national saving (S) is the sum of private savings (Sp) and the budget surplus (BS). The national saving and investment identity in an open economy is given by the equation S = I + NX, where I stands for investment and NX for net exports.

In this case, the national saving is calculated as follows:

• Private savings: 4,000
• Budget surplus: 1,000
• National saving (S = Sp + BS): 5,000

We then equate national saving to investment plus net exports (S = I + NX).

Given that investment (I) is 5,000, we can find the net exports (NX) by rearranging the equation:

NX = S - I

Since national saving (S) is 5,000 and investment (I) is also 5,000, the net exports (NX) is 0. This means that the balance of trade is zero, indicating that the value of exports equals the value of imports.

Changes in the Balance of Trade

If the budget surplus changes to a budget deficit of 1,000, we would adjust the national saving calculation:

• Private savings: 4,000
• Budget deficit: -1,000 (negative because it's a deficit)
• National saving (S = Sp + (BS)): 3,000

Keeping the investment constant at 5,000, the new net exports (NX) can be calculated:

NX = S - I

NX (now) = 3,000 (S) - 5,000 (I) = -2,000

The new balance of trade is -2,000, which indicates a trade deficit where the value of imports exceeds the value of exports by 2,000.