Question

Consider the following data for a closed economy: $$ \begin{aligned} Y &=\$ 12 \text { trillion } \\ C &=\$ 8 \text { trillion } \\ G &=\$ 2 \text { trillion } \\ S_{\text {Public }} &=-\$ 0.5 \text { trillion } \\ T &=\$ 2 \text { trillion } \end{aligned} $$ Use these data to calculate the following: a. Private saving b. Investment spending c. Transfer payments d. The government budget deficit or budget surplus

Short answer

a. Private saving is \$2 trillion, b. Investment spending is \$2 trillion, c. Transfer payments amount to \$0.5 trillion, d. There is a government budget deficit of \$0.5 trillion.

Step-by-step solution

Calculate Private Saving

In order to calculate private saving, we can use the following formula: \(S_{private} = Y - T - C\). Now we plug in the numbers: \(S_{private} = \$12 trillion - \$2 trillion - \$8 trillion = \$2 trillion\). Therefore, private saving is \$2 trillion.

Calculate Investment Spending

Investment spending can be calculated using the identity: \(I = Y - C - G\). By plugging in the numbers, we get: \(I = \$12 trillion - \$8 trillion - \$2 trillion = \$2 trillion\). Therefore, investment spending is \$2 trillion.

Calculate Transfer Payments

Transfer payments can be found using the equation: \(TR = G - T + S_{public}\). By plugging in the numbers, we get: \(TR = \$2 trillion - \$2 trillion - (-\$0.5 trillion) = \$0.5 trillion\). Therefore, transfer payments amount to \$0.5 trillion.

Calculate the Government Budget Deficit or Surplus

The government budget deficit or surplus can be calculated using the identity: \(Budget = T - G - TR\). Plugging in the numbers, we get: \(Budget = \$2 trillion - \$2 trillion - \$0.5 trillion = -\$0.5 trillion\). Since the result is negative, this represents a budget deficit of \$0.5 trillion.

Key concepts

Private Saving

Private saving is a core component of any economy. It represents the part of the income that households choose to save instead of spending on consumption or paying taxes. In a closed economy, private saving can be calculated using the formula: \[ S_{\text{private}} = Y - T - C \] where:

• \( Y \) is the total income, which is \( \\(12 \) trillion in this case.
• \( T \) is the total taxes paid, amounting to \( \\)2 \) trillion.
• \( C \) is the consumption expenditure, which is \( \\(8 \) trillion.

By inserting these values into the formula, we get: \[ S_{\text{private}} = \\)12 \text{ trillion} - \\(2 \text{ trillion} - \\)8 \text{ trillion} = \\(2 \text{ trillion} \] This calculation shows that households in this economy are choosing to save \\)2 trillion of their income. Private saving is crucial as it represents funds that can be invested back into the economy to fuel growth.

Investment Spending

Investment spending pertains to expenditures on capital goods that will be used to produce future goods and services. In a closed economy, we can determine this by employing the national income accounting identity: \[ I = Y - C - G \] where:

• \( I \) is the investment spending.
• \( G \) is the government expenditure, in this case \( \\(2 \) trillion.

By plugging the given numbers into the formula, we have:\[ I = \\)12 \text{ trillion} - \\(8 \text{ trillion} - \\)2 \text{ trillion} = \\(2 \text{ trillion} \] This means that the economy invests \\)2 trillion in capital goods. Investment is a vital part of the economic process as it enables the creation of new business ventures and replenishment of capital.

Government Budget

The government budget represents the financial health of the government, specifically the difference between its income and expenditure. The budget can either be in surplus, balanced, or in deficit. The budget balance is calculated using the formula:\[ \text{Budget} = T - G - TR \]where:

• \( TR \) is the transfer payments.

In this scenario, with \( T = \\(2 \) trillion, \( G = \\)2 \) trillion, and transfer payments of \( \\(0.5 \) trillion, the calculation is:\[ \text{Budget} = \\)2 \text{ trillion} - \\(2 \text{ trillion} - \\)0.5 \text{ trillion} = -\\(0.5 \text{ trillion} \]A negative result indicates a budget deficit of \\)0.5 trillion, highlighting that the government is spending more than its revenue, which could have implications for public policy and debt management.

Transfer Payments

Transfer payments are a form of government spending where money is transferred to individuals without the expectation of goods or services in return. These are important in understanding fiscal policies as they impact the overall economy by redistributing income.In this exercise, transfer payments are calculated with the formula:\[ TR = G - T + S_{\text{public}} \]Given:

• \( S_{\text{public}} \) represents public saving which is \(-\\(0.5\) trillion.

When we substitute the known values:\[ TR = \\)2 \text{ trillion} - \\(2 \text{ trillion} - ( -\\)0.5 \text{ trillion}) = \\(0.5 \text{ trillion} \]This indicates that the government is providing \\)0.5 trillion in transfer payments. Understanding transfer payments is crucial as they can significantly affect household income and thus influence overall consumption and saving.