Question 5 Chapter 18 Saving and net flows of capital and goods
An economy's gross domestic product ( ) is made up of four components: consumption,
... [Show More] investment,
government purchases, and net exports. Therefore, .
5. Saving and net flows of capital and goods
In a closed economy, saving and investment must be equal, but this is not the case in an open economy. In
the following problem, you will explore how saving and investment are connected to the international flow of
capital and goods in an economy. Before delving into the relationship between these various components of
an economy, you will be asked to recall some relationships between aggregate variables that will be useful in
your analysis.
Recall the components that make up GDP. National income ( ) equals total expenditure on the economy's
output of goods and services. Thus, where = consumption, = investment, = government
purchases, = exports, = imports, and = net exports:
Points: 1 / 1
Also, national saving is the income of the nation that is left after paying for
. Therefore, national saving ( ) is defined as:
Points: 1 / 1
Points: 1 / 1
Explanation: Close Explanation
National saving is the income of the nation that is left after paying for government purchases and
consumption. Therefore, . Rearranging this for yields . Plugging this into
the original equation for GDP, ( ) results in:
government purchases and consumption
Explanation: Close Explanation
Because net exports must equal the net flow of capital ( ), it must also be true that .
Rearranging the previous equation and solving for yields = . Plugging this into the original
equation showing the various components of GDP results in thefollowing relationship:
Points: 1 / 1
Points: 1 / 1
This is equivalent to = , since net exports must equal net capital outflow ( ,also
known as net foreign investment).
Points: 1 / 1
Now suppose that a country is experiencing a trade surplus. Determine the relationships between the entries
in the following table, and enter these relationships using the following symbols: > (greater than), < (less
than), or = (equal to).
Outcomes of a Trade Surplus
Exports
0
Imports
Net Exports
Investment
0
Saving
Net Capital Outflow
Points: 0 / 1
<
>
<
<
<
Explanation: Close Explanation
If a country is experiencing a trade surplus, then the value of exports exceeds the value of imports.
Because net exports is defined as exports minus imports, this implies that net exports must be greater
than zero. Since you know that income ( ) is equal to , if net exports is positive, this
means that income is greater than domestic spending ( ). As you saw in the previous
question, saving is what is left over from income after consumption and government purchases
( ). Therefore:
>
>
>
Because the country is saving more than it is investing, some of its saving must be going abroad.
Therefore, net capital outflow must be positive. [Show Less]