Question

Suppose the U.S. has a closed economy with GDP (Y) equal to $20.3 trillioh, consumpbon L) equal to $11.0 trillion, government spending (G) equal to $3.8 trillion, transfer payments (TR) equal to $1.0 trillion, and taxes (T) equal to $3,6 trillion. Suppose the government increases its spending on national defense such that government spending increases by $0.6 trillion. What must happen to total savings (S)? That is, what is the dollar amount by which total savings changes? Assume the values for GDP, consumption, taxes, and transfer payments do not change. Provide your answer in trillions of dollars rounded to one decimal place. Use a negative sign " for negative changes. Do not include any symbols, such as "$", "%" or ","in your answer.

Answer 1

The U.S. government’s increase in spending by $0.6 trillion will lead to a decrease in total savings in the economy by $0.6 trillion. This is calculated using the closed economy national income identity, which relates GDP, consumption, investment, and government spending.

Step-by-step explanation:

When the U.S. government increases its spending by $0.6 trillion without changing its taxes, the government's budget deficit will increase. Assuming there is no change in GDP, consumption, taxes, and transfer payments, the total savings in the economy must decrease by the same amount of the increase in government spending.

The closed economy national income identity states that GDP (Y) is the sum of consumption (C), investment (I), and government spending (G), which can be written as Y = C + I + G. In a closed economy without trade, net exports are zero, and therefore, the savings identity can be rearranged to S = Y - C - G - (T - TR). Before the increase in spending, savings can be calculated:

S = 20.3 - 11.0 - 3.8 - (3.6 - 1.0) = 20.3 - 11.0 - 3.8 - 2.6 = 2.9 trillion dollars

After the increase in government spending:

S = 20.3 - 11.0 - (3.8 + 0.6) - (3.6 - 1.0) = 20.3 - 11.0 - 4.4 - 2.6 = 2.3 trillion dollars

The total savings will decrease by the amount government spending increases, so total savings changes by -0.6 trillion dollars.