Question

Total income of residents (Yp) is equal to gross income (Y) minus taxes (T) plus net income
from international transfers (R). Private sector total savings is S = Yp – C. The domestic
absorption of total expenditure is private sector consumption (C) plus investment (I) plus
government expenditure (G), and foreign demand equals net export (i.e. export X minus
import Z). Based on these identities answer the following:
a) The current account of the balance of payments (defined as X–Z–R) is equal to what? To
find it out, you have to derive an equation between the foreign sector and domestic net
absorption, show all the steps!
b) If the current account value is minus five percent of GDP and the government budget is in
deficit of 2% (of GDP), then which of the following is true: I=S or S<I or S>I? Explain why so.
c) If the private sector net savings equal to 1% and the government budget deficit in 2%
(relative to GDP both), then which of the following is true: X=Z or X<Z or X>Z?

Answer 1

Disposable Income YP = Y- T + R where T = Tax and R = International Transfer

Saving S = YP - C

Domestic Product Y = C + I + G; where C = Consumption, I = Investment and G = Government Expenditure

Net Exports = Exports - Imports

Current Account Deficit = 1% of GDP

Currenct Account = Net Exports + net income from abroad + net current transfer

It is in deficit of 1% of GDP

Government run a budget of deficit of 3% of GDP in 2015

Saving S = YP - C

= (Y - T + R) - C

= {(C + I + G) -T + R} -C

=C +I +G - T + R - C

= I + G -T +R

Therefore, Net Saving is equal to the sum of Investment, Government Expenditure and Net Foreign Return minus the taxes with respect to GDPj