a)Write down the national account identify for a closed economy. Then, show the

Question

a)Write down the national account identify for a closed economy. Then, show the identity between national savings (i.e. the sum of private savings and government savings) and investment. You must show all of the steps.

b)Write down the national account identity for an open economy. Again, show the identity between national savings (i.e. the sum of private savings and government savings) and investment. Show all of your steps.

c)Based on the saving and investment relationship in the closed economy in Part a), explain how an increase in government purchases (G) can affect growth in output per worker. We assume that the taxes that the government collects remain unchanged.

Explanation / Answer

If

C: Consumption spending,

I: Investment spending,

G: Government expenditure and

X: Exports and

M: Imports,

(a) In a closed economy, output is

Y = C + I + G

Y - C = I + G

S = I + G, where S = Y - C = private saving

S - G = National saving = I

(b) In an open economy, identity is

Y = C + I + G + X - M

Y - C - G = I + X - M

National saving = I + X - M

(c)

For the close economy, as G increases, output Y increases as well. Higher output increases output per worker (assuming population grows at a lower rate than growth in Y), so it leads to higher growth in output per worker.

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