Question

9. Economists in the country of Flatland, a closed economy, have collected the following information about their economy for a particular year: Y=15,000; C=9,000; T=3,000; G=3,600. The economists also estimate that the investment function is I=3,900-100r, where r is the country’s real interest rate, expressed as a percentage.

Calculate private saving, public saving, national saving, investment, and the equilibrium real interest rate. Does the government of Flatland have a budget surplus or budget deficit?

Answer 1

Private saving (Sprivate) is equal to disposable income minus consumption:

Sprivate = Y - T - C = 15,000 - 3,000 - 9,000 = 3,000

Public saving (Spublic) is equal to government revenue minus government spending:

Spublic = T - G = 3,000 - 3,600 = -600

National saving (S) is equal to the sum of private and public saving:

S = Sprivate + Spublic = 3,000 - 600 = 2,400

Investment (I) is given by the investment function:

I = 3,900 - 100r

Equating investment to national saving gives:

I = S

3,900 - 100r = 2,400

Solving for r:

r = 15%

Therefore, the equilibrium real interest rate is 15%.

Substituting r = 15% into the investment function gives:

I = 2,400

Therefore, investment is 2,400.

Finally, to determine if the government has a budget surplus or deficit, we need to calculate the government's budget balance, which is equal to government revenue minus government spending:

Budget balance = T - G = 3,000 - 3,600 = -600

Since the budget balance is negative, the government of Flatland has a budget deficit.