Assume an economy has a budget surplus of 1,000 private savings of 4,000 and investment of 5,000.
a. write out a national saving and investment identity for this economy.
b. what will be the balance of trade in this economy.
c. if the budget deficit changes to a budget surplus of 1,000 with private saving and
d. based on the national saving and investment identity, in general, what are the three ways the macro-economy might react to greater government budget deficits?

Detailed answer given below for each section

Explanation:

A) Since the government has a budget surplus, the government budget term appears with the supply of capital. The following shows the national savings and investment identity for this economy :

Quantity supplied of financial capital = Quantity demanded of financial capital

                                           S + ( T - G ) = I + ( X -M )

where, S = Private saving, (T-G) = Government surplus, I = Private Investment, (X-M) = outflow of foreign saving

B) Plugging the given values into the identity shown in the part (a), we find that (X – M) = 0

C) Since the government has a budget deficit, the government budget term appears with the demand for capital. You do not know in advance whether the economy has a trade deficit or a trade surplus. But when you see that the quantity demanded of financial capital exceeds the quantity supplied, you know that there must be an additional quantity of financial capital supplied by foreign investors, which means a trade deficit of 2000. This example shows that in this case there is a higher budget deficit, and a higher trade deficit.

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