Chapter 6, Problem 2PA

Subpart (a):

To determine

Private saving, public saving, national saving, investment, trade balance, and equilibrium exchange rate.

Explanation of Solution

The consumption is calculated as follows:

$\begin{array}{c}\text{C}=500+\frac{2}{3}\left(\text{Y}-\text{T}\right)\\ =500+\frac{2}{3}\times \left(\text{8,000}-\text{2,000}\right)\\ =500+\frac{2}{3}\times 6,000\\ =500+2\times 2,000\\ =500+4,000\\ =4,500\end{array}$

The consumption is 4,500.

The private saving is calculated as follows:

$\begin{array}{c}\text{Private savings}=\text{Y}-\text{C}-\text{T}\\ =8,000-4,500-2,000\\ =8000-6,500\\ =1,500\end{array}$

The private savings is1,500.

The public saving is calculated as follows:

$\begin{array}{c}\text{Public savings}=\text{T}-\text{G}\\ =2,000-2,500\\ =-500\end{array}$

The public savings is -500.

The national savings (S) is calculated as follows:

$\begin{array}{c}\text{National savings}=\text{Private savings +Public savings}\\ =1,500+\left(-500\right)\\ =1,000\end{array}$

The national savings (S) is 1,000.

Investment I is calculated as follows:

$\begin{array}{c}\text{I}=900-50\text{r}\\ =900-\left(50\times 8\right)\\ =900-400\\ =500\end{array}$

Investment I is 500.

The trade balance (net exports) NX is calculated as follows:

$\begin{array}{c}\text{NX}=\text{S}-\text{I}\\ \text{=1,000}-500\\ =500\end{array}$

The trade balance is 500.

The given NX is 500, the equilibrium exchange rate can be found by solving the equation given below:

$\begin{array}{c}\text{NX}=1,500-250\text{ε}\\ 500=1,500-250\text{ε}\\ 250\text{ε}=1,500-500\\ 250\text{ε}=1,000\\ \text{ε}=\frac{1,000}{250}\\ \text{ε}=4\end{array}$

The equilibrium exchange rate is 4%.

Economics Concept Introduction

Saving: The savings refers to as the level of amount remaining after all the consumption expenditure deducted from the sum of disposable income at a time period.

Consumption spending: Consumption spending refers to the amount of expenditure incurred for consuming the goods and services at a particular time period with the given level of income.

Real exchange rate: Real exchange rate can be defined as the relative price of goods or services of two countries, which is the rate at which one can exchange the goods and services of one country for the goods and services of another.

Investment: An investment refers to the buying or accumulation of new capital goods, such as tools, factories, machinery for producing the goods, and services.

Subpart (b):

To determine

The calculation of private saving, public saving, national saving, investment, trade balance, and equilibrium exchange rate when G is 2,000.

Explanation of Solution

The consumption is calculated as follows:

$\begin{array}{c}\text{C}=500+\frac{2}{3}\left(\text{Y}-\text{T}\right)\\ =500+\frac{2}{3}\times \left(\text{8,000}-\text{2,000}\right)\\ =500+\frac{2}{3}\times 6,000\\ =500+2\times 2,000\\ =500+4,000\\ =4,500\end{array}$

The consumption is 4,500.

The private saving is calculated as follows:

$\begin{array}{c}\text{Private savings}=\text{Y}-\text{C}-\text{T}\\ =8,000-4,500-2,000\\ =8000-6,500\\ =1,500\end{array}$

The private savings is1,500.

The public saving is calculated as follows:

$\begin{array}{c}\text{Public savings}=\text{T}-\text{G}\\ =2,000-2,000\\ =0\end{array}$

The public savings is 0.

The national savings (S) is calculated as follows:

$\begin{array}{c}\text{S}=\text{Private savings +Public savings}\\ =1,500+0\\ =1,500\end{array}$

The national savings (S) is 1,500.

Investment I is calculated as follows:

$\begin{array}{c}\text{I}=900-50\text{r}\\ =900-\left(50\times 8\right)\\ =900-400\\ =500\end{array}$

Investment I is 500.

The trade balance (net exports) NX is calculated as follows:

$\begin{array}{c}\text{NX}=\text{S}-\text{I}\\ \text{=1,500}-500\\ =1,000\end{array}$

The trade balance is 1,000.

The given NX is 1,000, the equilibrium exchange rate can be found by solving the equation as follows:

$\begin{array}{c}\text{NX}=1,500-250\text{ε}\\ 1,000=1,500-250\text{ε}\\ 250\text{ε}=1,500-1,000\\ 250\text{ε}=500\\ \text{ε}=\frac{500}{250}\\ \text{ε}=2\end{array}$

The equilibrium exchange rate is 2%.

The decrease in government expenditure G increases national saving S. The investment remains the same with no change in the interest rate r. As a result, the $\left(\text{S}-\text{I}\right)$ increases, which is the net capital flow. This implies the net export also increases. As a result, the real exchange rate depreciates in order to equate the net exports to the net capital flow.

Economics Concept Introduction

Saving: The savings refers to as the level of amount remaining after all the consumption expenditure deducted from the sum of disposable income at a time period.

Consumption spending: Consumption spending refers to the amount of expenditure incurred for consuming goods and services at a particular time period with the given level of income.

Real exchange rate: Real exchange rate can be defined as the relative price of goods or services of two countries, which is the rate at which one can exchange the goods and services of one country for the goods and services of another.

Depreciation of currency: The depreciation of currency implies decrease in the value of currency of respective country.

Investment: An investment refers to the buying or accumulation of new capital goods, such as tools, factories, machinery for producing the goods, and services.

Subpart (c):

To determine

Calculation of private saving, public saving, national saving, investment, trade balance, and equilibrium exchange rate when the world interest rate is 3 and G is 2,500.

Explanation of Solution

The consumption is calculated as follows:

$\begin{array}{c}\text{C}=500+\frac{2}{3}\left(\text{Y}-\text{T}\right)\\ =500+\frac{2}{3}\times \left(\text{8,000}-\text{2,000}\right)\\ =500+\frac{2}{3}\times 6,000\\ =500+2\times 2,000\\ =500+4,000\\ =4,500\end{array}$

The consumption is 4,500.

The private saving is calculated as follows:

$\begin{array}{c}\text{Private savings}=\text{Y}-\text{C}-\text{T}\\ =8,000-4,500-2,000\\ =8000-6,500\\ =1,500\end{array}$

The private savings is1,500.

The public saving is calculated as follows:

$\begin{array}{c}\text{Public savings}=\text{T}-\text{G}\\ =2,000-2,500\\ =-500\end{array}$

The public savings is -500.

The national savings (S) is calculated as follows:

$\begin{array}{c}\text{S}=\text{Private savings +Public savings}\\ =1,500+\left(-500\right)\\ =1,000\end{array}$

The national savings (S) is 1,000.

Investment I is calculated as follows:

$\begin{array}{c}\text{I}=900-50\text{r}\\ =900-\left(50\times 3\right)\\ =900-150\\ =750\end{array}$

Investment I is 750.

The trade balance (net exports) NX is calculated as follows:

$\begin{array}{c}\text{NX}=\text{S}-\text{I}\\ \text{=1,000}-750\\ =250\end{array}$

The trade balance is 250.

The given NX is 250, the equilibrium exchange rate can be found by solving the equation given below:

$\begin{array}{c}\text{NX}=1,500-250\text{ε}\\ 250=1,500-250\text{ε}\\ 250\text{ε}=1,500-250\\ 250\text{ε}=1,250\\ \text{ε}=\frac{1,250}{250}\\ \text{ε}=5\end{array}$

The equilibrium exchange rate is 5%.

Even though the national saving S remains unchanged, investment increases the fall on interest rate r. As a result, the $\left(\text{S}-\text{I}\right)$ decreases and it reduces the net capital outflow. This implies the net export also decreases. As a result, the real exchange rate appreciates in order to equate the net exports to the net capital flow.

Economics Concept Introduction

Saving: The savings refers of the level of amount remaining after all the consumption expenditure deducted from the sum of disposable income at a time period.

Consumption spending: Consumption spending refers to as the amount of expenditure incurred for consuming goods and services at a particular time period with the given level of income.

Real exchange rate: Real exchange rate can be defined as the relative price of goods or services of two countries, which is the rate at which one can exchange the goods and services of one country for the goods and services of another.

Appreciation of currency: The appreciation of currency implies increase in the value of currency of that country.

Investment: An investment refers to as the buying or accumulation of new capital goods, such as tools, factories, machinery for producing the goods, and services.