<< Chapter < Page Chapter >> Page >

Now, consider the factors on the left-hand side of the equation one at a time, while holding the other factors constant.

As a first example, assume that the level of domestic investment in a country rises, while the level of private and public saving remains unchanged. The result is shown in the first row of [link] under the equation. Since the equality of the national savings and investment identity must continue to hold—it is, after all, an identity that must be true by definition—the rise in domestic investment will mean a higher trade deficit. This situation occurred in the U.S. economy in the late 1990s. Because of the surge of new information and communications technologies that became available, business investment increased substantially. A fall in private saving during this time and a rise in government saving more or less offset each other. As a result, the financial capital to fund that business investment came from abroad, which is one reason for the very high U.S. trade deficits of the late 1990s and early 2000s.

Causes of a changing trade balance
Domestic Investment   – Private Domestic Savings   – Public Domestic Savings   = Trade Deficit
I S (T – G) = (M – X)
Up No change No change Then M – X must rise
No change Up No change Then M – X must fall
No change No change Down Then M – X must rise

As a second scenario, assume that the level of domestic savings rises, while the level of domestic investment and public savings remain unchanged. In this case, the trade deficit would decline. As domestic savings rises, there would be less need for foreign financial capital to meet investment needs. For this reason, a policy proposal often made for reducing the U.S. trade deficit is to increase private saving—although exactly how to increase the overall rate of saving has proven controversial.

As a third scenario, imagine that the government budget deficit increased dramatically, while domestic investment and private savings remained unchanged. This scenario occurred in the U.S. economy in the mid-1980s. The federal budget deficit increased from $79 billion in 1981 to $221 billion in 1986—an increase in the demand for financial capital of $142 billion. The current account balance collapsed from a surplus of $5 billion in 1981 to a deficit of $147 million in 1986—an increase in the supply of financial capital from abroad of $152 billion. The two numbers do not match exactly, since in the real world, private savings and investment did not remain fixed. The connection at that time is clear: a sharp increase in government borrowing increased the U.S. economy’s demand for financial capital, and that increase was primarily supplied by foreign investors through the trade deficit. The following Work It Out feature walks you through a scenario in which private domestic savings has to rise by a certain amount to reduce a trade deficit.

Solving problems with the saving and investment identity

Use the saving and investment identity to answer the following question: Country A has a trade deficit of $200 billion, private domestic savings of $500 billion, a government deficit of $200 billion, and private domestic investment of $500 billion. To reduce the $200 billion trade deficit by $100 billion, by how much does private domestic savings have to increase?

Step 1. Write out the savings investment formula solving for the trade deficit or surplus on the left:

(X – M)  =  S +  (T – G)  – I

Step 2. In the formula, put the amount for the trade deficit in as a negative number (X – M). The left side of your formula is now:

–200  =  S + (T – G) – I

Step 3. Enter the private domestic savings (S) of $500 in the formula:

   –200  =  500  + (T – G) – I

Step 4. Enter domestic investment (I) of $500 into the formula:

       –200  =  500  + (T – G) – 500

Step 5. The government budget surplus or balance is represented by (T – G). Enter a budget deficit amount for (T – G) of –200:

      –200  =  500  + (–200) – 500

Step 6. Your formula now is:

(X – M)  =  S + (T – G) – I –200  =  500 + (–200) – 500

The question is: To reduce your trade deficit (X – M) of –200 to –100 (in billions of dollars), by how much will savings have to rise?

(X – M)  =  S + (T – G) – I –100  =  S + (–200)  –  500 600  =  S

Step 7. Summarize the answer: Private domestic savings needs to rise by $100 billion, to a total of $600 billion, for the two sides of the equation to remain equal (–100 = –100).

Questions & Answers

The equation for a demand curve is P = 48 – 3Q. What is the elasticity in moving from a quantity of 5 to a quantity of 6?
Abdul Reply
mo na pane reponse la accause li tro compliker essay guet avec banne lezot dimune
Abdel
Difference between demand and supply
Amuzu Reply
The quantity that is demanded will be the amount of that product that people are willing to purchase at a certain price; the relationship between quantity demanded and the price is called the demand relationship. Whereas, Supply does represent how much the whole market can offer a certain product or
Rahul
What is resource maintenance
Linda Reply
it is the optimum and continous supply of resources to undertake a task whether manufacturing or service.
Sajad
RM emphasizes a team approach to human error reduction using principles that seek to improve communications, situational awareness, problem solving, decision making, and teamwork by making the availability of facilities,of funding , personnel, spare parts , technical data, test equipments, and tools
Deep
why economics is a social science
Madag Reply
Economics is generally regarded as a social science, which revolves around the relationships between individuals and societies
Rahul
what is planned demand and actual demand?
Jincy
The terms demand planning and demand forecasting are often used interchangeably. Though they are unmistakably linked in the supply chain management process, they are not the same thing. ... Demand planning is a process; accurate forecasts are the results of an effective demand planning process
Rahul
economics projection on how the cost of living , the facilities that can be enhanced or acquired can be utilised and maintained best. How change in demand and supply effect actual social strata and economic earning. the science in economics is the allied application to make society a welfare state
Srikumar
what is repo rate ?
Ankit
Demand planning and sales forecasting is one of the key aspects of manufacturing operations. This is because manufacturing operations need to accurately estimate demand in order to produce the correct amount of goods within a given time
Deep
what is opportunity cost
Linda Reply
opportunity cost, or alternative cost, is the loss of potential gain from other alternatives when one particular alternative is chosen over the others. In simple terms, opportunity cost is the loss of the benefit that could have been enjoyed had a given choice not been made. 
Rahul
when the difference in output to input is either >1 or enhancement of resources are done to rationalise utility we forego a process to maximize on next best opportunity which will be effective change in cost than can be overcome or foregone to get the best result
Srikumar
Thank you
Linda
what is quantity demanded
Oke Reply
Quantity demanded is the quantity of a commodity that people are willing to buy at a particular price at a particular point of time.
Tendai
ok
Duy
what is rational behavior
Kpienta Reply
This is a part of decision making practice wherein an individual/company exercises sensible choice making, which provides him with the optimum amount of benefit.
Sajad
consumer is said to be rational if he or she buys goods which gives maximum satisfaction at a lower price
Duk
defination of perfect Competition
Fatima Reply
is a type of market form in which their are many companies that sell the same products and service
Modou
current economic plans (MDGS) needs
Ajijola Reply
I don't know what is happening
surajkumar
What is economic
Joeali Reply
What is the importance of study economics
Wilma
Economic is the study of how humans make decisions in face of sacristy
Wilma
economics is the study of how humans makes decision in the face of scarcity
Kpienta
economics is the study of human behaviour when faced with difficult situation example when goods and services are scarcity.
Sydney
Economic is the study of human behaviour
Chibuzo
what is Economic
Dauda Reply
what is 4ps of economic?
thomas Reply
production place Price product
Benedict
Criticism of elasticity
Siddikur Reply
what is unemployment
Gyamfi Reply
ohk thanks
Gyamfi
why is unemployment rapid in the country
Gyamfi
I need more explanation
Odo
1st-due to poorly government planning on employment opportunities, 2nd-low level of science and technology can leads to unemployment,3rd education level
Isack
fiscal monitory policy
Abubakar
thi can be said to be,the level of joblessness in an economy.
Omar
I mean "this "
Omar
what is unemployment
Munanag Reply
not working
Bethel
some one who is willing qualified to work but can't find job
jackie
Bethel...explain? please
Abubakar
some one who is willing to work but can't find job
Hawa
Yes true
Brian
which one please
Hawa
unemployment refers to the ability for someone who is capable and willing to work but could not find a job..
Mnoko
some one who not able to find a job
Dennis
please what is the secret of learning?
thomas

Get Jobilize Job Search Mobile App in your pocket Now!

Get it on Google Play




Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Principles of economics' conversation and receive update notifications?

Ask