Question

A country finds itself in the following situation: a government budget surplus of $900; total domestic savings of $200, and total domestic physical capital investment of $1300. According to the national saving and investment identity, if investment decreases by $300 while the government budget deficit and savings remain the same, what will happen to the current account balance?

Answer 1

Answer:

The current account balance goes from a $200 deficit, to a $100 surplus.

Explanation:

There are several ways to write the national saving and investment identity. We can choose to write it in this way:

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

Because the equation is an identity, we know that the left side of it (X - M) will always be equal to the right side (S + (T - G) - I), on which we wil be focusing.

With the initial values provided by the question, we have the following situation:

(X - M) = $200 + $900 - $1,300

(X - M) = $1,100 - $1,300

(X - M) = -$200

Thus, we have a deficit of $200

If investment decreases by $300, while the government budget, and savings remain the same, the situation changes:

(X - M) = $200 + $900 - $1,000

(X - M) = $1,100 - $1,000

(X - M) = $100

So now we have a surplus of $100