Question

Consider the following data for a closed economy: $$ \begin{aligned} Y &=\$ 11 \text { trillion } \\ C &=\$ 8 \text { trillion } \\ I &=\$ 2 \text { trillion } \\ T R &=\$ 1 \text { trillion } \\ T &=\$ 3 \text { trillion } \end{aligned} $$ Use these data to calculate the following: a. Private saving b. Public saving c. Government purchases d. The government budget deficit or budget surplus

Short answer

a. Private saving is \$1 trillion, b. Public saving is also \$1 trillion, c. Government purchases are \$1 trillion, d. There is a government budget surplus of \$1 trillion.

Step-by-step solution

Calculate Private Saving

Private saving is the difference between disposable income and consumption. Disposable income is essentially the gross domestic product (Y) minus taxes (T) plus transfer payments (TR). Given that Y = \$11 trillion, T = \$3 trillion, and TR = \$1 trillion, the disposable income is therefore \$11 trillion - \$3 trillion + \$1 trillion = \$9 trillion. With C given as \$8 trillion, the private saving is \$9 trillion - \$8 trillion = \$1 trillion.

Calculate Public Saving

Public saving is the difference between tax revenue and the sum of government purchases and transfer payments. As we don't know government purchases (G) yet, we will calculate it in the next step.

Calculate Government Purchases

To calculate government purchases, we use the fundamental equation of the economy: Y = C + I + G. Here, Y is 11 trillion, C is 8 trillion, and I is 2 trillion. Thus, G can be calculated as G = Y - C - I = \$11 trillion - \$8 trillion - \$2trillion = \$1 trillion.

Calculate Public Saving again

Now that we know G, we can plug it back into our equation for public saving. This means public saving = T - G - TR = \$3 trillion - \$1 trillion - \$1 trillion = \$1 trillion.

Determine the Government Budget Deficit or Surplus

The government has a budget surplus if public saving is positive, and a budget deficit if it is negative. Since our calculated public saving is \$1 trillion (which is a positive amount), there is a government budget surplus of \$1 trillion.

Key concepts

Private Saving

Private saving is an essential concept in national income accounting and refers to how much income households have left after fulfilling their tax obligations and major expenses. To calculate it, you start with disposable income.
Disposable income is the income that households have available for spending and saving after taxes and any transfer payments from the government are taken into account. In mathematical terms, disposable income is calculated as the Gross Domestic Product (GDP), minus taxes, plus transfer payments.

• Disposable Income = GDP - Taxes + Transfer Payments

Given the exercise data, with GDP (\( Y \)) of \(11 trillion, taxes (\( T \)) of \)3 trillion, and transfer payments (\( \text{TR} \)) of \(1 trillion, we calculate disposable income as:

• Disposable Income = \)11 trillion - \(3 trillion + \)1 trillion = \(9 trillion

The private saving is then calculated by subtracting consumption from disposable income. Consumption (\( C \)) is given as \)8 trillion in the exercise, so:

• Private Saving = Disposable Income - Consumption = \(9 trillion - \)8 trillion = $1 trillion

Private saving represents the portion of disposable income not spent on current consumption. It's crucial as it could be used for future investments.

Public Saving

Public saving is a key component in understanding how the government balances its revenue against its spending. It's essentially the difference between what's collected in taxes and what's expended by the government on public services and transfer payments.
When public saving is positive, it indicates a surplus where government income exceeds spending. Conversely, negative saving indicates a deficit. To calculate public saving, we can use the formula:

• Public Saving = Tax Revenue - Government Spending - Transfer Payments

In the exercise, the tax revenue (\( T \)) is \(3 trillion, government spending (\( G \)) is now known to be \)1 trillion, and transfer payments (\( \text{TR} \)) are \(1 trillion. Hence:

• Public Saving = \)3 trillion - \(1 trillion - \)1 trillion = $1 trillion

If public saving is positive, like in this example, it reflects a budget surplus, providing the government with leverage to either invest in various public projects or reduce existing public debt.

Government Budget

The government budget is a vital aspect of economic health, showing the balance of revenue against expenditure. It's crucial for assessing whether a government incurs a surplus or deficit.
The government budget is influenced by several factors, including public saving and government purchases. In this case, public saving was calculated to be $1 trillion. This indicates a government budget surplus, as the revenue from taxes exceeds government expenses.

• Government budget surplus = Positive public saving
• Government budget deficit = Negative public saving

The concept of a budget surplus implies that the government can use the excess to invest or decrease national debt, whereas a budget deficit might require borrowing. Understanding this balance helps governments make informed fiscal policy decisions.

Closed Economy

A closed economy is one of the foundational concepts in macroeconomic theory. It refers to an economy that does not engage in international trade of goods and services. All economic activity within a closed economy occurs domestically.
Key assumptions of a closed economy include:

• No Imports or Exports
• The economy is self-sufficient
• All resources for production and consumption are sourced internally

Given this, the national income accounting identity for a closed economy is expressed as:

• GDP = Consumption (\( C \)) + Investment (\( I \)) + Government Spending (\( G \))

In the exercise, we utilized this identity to determine the government purchases by rearranging the formula. A closed economy provides the simplest model for analyzing economic activities, however, it's important to note that in reality, most economies are open and involve complex international transactions.