Problem 2 Consider the following information about the open economy of Regalia.

Question

Problem 2 Consider the following information about the open economy of Regalia. There are no government transfers. (Note: capital inflow = the value of imports (IM) minus the value of exports (X)). Make sure you show your work in your answers. GDP= $1,000 million G-$100 million X = $100 million IM $125 million C = $850 million T = $50 million (1) What is the level of investment spending? (2) What is the level of private savings? (3) What is the level of government savings? (4) What is the level of foreign savings? (5) What is the relationship among your answers to (1), (2), (3) and (4)? (Verify that the investment-savings identity holds true.)

Explanation / Answer

Y=C+I+G+NX

NX=IM-X

Government transfer, TR=0;Tax, TA=$50 million

Also, Y=S+C

1000=S+850

Therefore, Private savings= $150 milion

To calculate investment spending, take GDP equation,

1000=850+I+100+(125-100)

1000=850+I+100+25

1000=975+I

I=$25 million

To calculate government savings,

S-I=G+TR-TA+NX

S-25=100-50+0+25

S=$100 million

Foreign savings =$25 million as the imports is higher than the exports by $25 million.

Investment savings identity is, I=Y-C=S

I=1000-850=$150 million

which holds true for te private savings.

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